Transfer of Property to a Corporation Under Section 85
NO.: IC 76-19R3
DATE : June 17, 1996
SUBJECT: Transfer of Property to a Corporation Under Section 85
This Circular cancels and replaces Information Circular 76-19R2 dated June 15, 1990. It provides information and guidance to help you make elections under subsections 85(1) and (2) of the Income Tax Act for certain types of property transferred to a corporation. You should read this circular in conjunction with Forms T2057 and T2058, and Interpretation Bulletins IT-169 and IT-291. Any reference to an Interpretation Bulletin or Information Circular in this circular refers to the current version of that bulletin or circular.
This Information Circular incorporates the 1991 to 1994 amendments to the Income Tax Act and clarifies the departmental policies. It does not include any comment on 1995 draft legislation.
Where applicable, Revenue Canada has extended its position on section 85 elections to elections under subsection 93(1), Election re disposition of share in foreign affiliate, subsection 97(2), Rules where election by partners, and subsection 98(3), Rules applicable where partnership ceases to exist. You should use Form T2107, Election in Respect of a Disposition of Shares in a Foreign Affiliate, Form T2059, Election on Disposition of Property by a Taxpayer to a Canadian Partnership, and Form T2060, Disposition of Property Upon Cessation of Partnership respectively to make these elections. The Department's views on the merger or amalgamation of Canadian partnerships are set out in IT-471, Merger of Partnerships
1. Subsection 85(1) permits a taxpayer, and subsection 85(2) permits all members of a partnership to elect to defer all or part of the income which would otherwise arise on the transfer of certain types of property to a taxable Canadian corporation. This section provides that you, as the taxpayer, can make the transfer at an agreed amount on which the Act imposes various limitations. You have to elect a dollar amount, as opposed to making a descriptive election, in setting the agreed amount for the purposes of subsection 85(1). You may amend (see paragraph 15) but you cannot revoke an election filed under section 85.
2. The rules in section 85 apply to each property transferred. Accordingly, if the parties intended but failed to include a particular property transferred when filing an original election form, we will consider that the transferor disposed of the omitted property for proceeds equal to the fair market value. However, according to subsection 85(7) or 85(7.1), the parties may file an additional election for that property after the date the election was otherwise due (see paragraph 15).
3. Although Form T2057, Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation, and Form T2058, Election on Disposition of Property by a Partnership to a Taxable Canadian Corporation, require a specific and adequate description of each property transferred, the parties to the election can exercise some discretion when transferring many properties. For example, if you are transferring all the depreciable properties of a prescribed class, it is not necessary to list each property, or show the consideration for each on the election form. Instead, you have to indicate on the form only the total fair market value of the properties, the lesser of the undepreciated capital cost and the cost of the properties, the fair market value of the consideration received, and the agreed amount for the whole class. However, you must retain supporting schedules. They are particularly important to determine the designated order of disposition of each depreciable property, as described in IT-291, Transfer of Property to a Corporation under Subsection 85(1).
4. The Department will accept elections reporting a nominal amount as the agreed amount for the transfer of property, provided that the amount is within the limitations imposed in the relevant paragraphs e.g., 85(1)(c), (c.1), (c.2), (d), and (e).
5. Paragraph 85(1)(d) ensures that the agreed amount for eligible capital property for a business cannot be less than the least of 4/3 of the cumulative eligible capital of that business, the cost, and the fair market value. When the lowest of these amounts is zero (e.g., earned goodwill for which there is no cost) and the parties intended to transfer the property on a tax-deferred basis, the parties still have to list the property on Form T2057 and state a nominal amount. If the parties transfer goodwill and do not include it on the prescribed form, we will consider it to be disposed of at its fair market value. It may be possible to avoid this tax consequence by filing a late election (see paragraphs 2 and 15 to 18). For more information, refer to IT-143, Meaning of Eligible Capital Expenditure, and IT-123, Transactions Involving Eligible Capital Property.
6. Forms T2057 and T2058 require you to disclose the fair market value of both the property disposed of and of the non-share consideration received. You should keep the working papers used to arrive at these values.
7. Even though you may list several properties on a single election form, section 85 requires a separate agreed amount for each property transferred. The Department will adjust an election form to disregard all references to a transfer of an ineligible property, without affecting the validity of the other transfers. There may be tax consequences in transferring ineligible properties. Therefore, it is important to ensure that you include only eligible properties in any election filed under section 85.
8. Under section 85, the consideration that the transferor receives for the property transferred to the corporation has to include at least one share (or fraction of a share) of the capital stock of that corporation for the election to be valid.
9. Form T2057 applies to elections made under subsection 85(1). Transferors must file this form separately from any income tax return at the tax centre where they file their tax returns. The transferor, or a person authorized in writing on the transferor's behalf, and the authorized officer of the transferee have to sign the election form.
10. Two or more transferors may elect to transfer the same property, or a number of partners may transfer their partnership interests. In these situations, one designated person should file all the completed T2057 forms and a list of all the electing transferors simultaneously at the tax centre serving the transferee corporation. We will accept the signature of the person that the transferors authorized to act on their behalf if that person has provided proof of authority. The designated person has to provide the address and social insurance number, or the corporation account or business number for each transferor resident in Canada.
11. For a transferor that is a partnership, one partner designated by the partnership should file Form T2058. All partners, or a person authorized in writing by the partners to sign for them, has to sign the election form, along with an authorized officer of the transferee. We will accept the signature of the designated partner only if the partnership provides proof of authority. The partnership has to file the election form separately from any income tax return, at the tax centre where the transferee usually files its income tax return. (See comments on the transfer of property to a corporation by a partnership under subsection 85(2) in IT-378, Winding-up of a Partnership.)
12. The deadline to file forms T2057 and T2058 is the earliest date on which any of the parties to the election has to file an income tax return for the taxation year in which the transfer occurred. Under subsection 150(1), an individual has to file an income tax return for the calendar year in which the individual disposed of a capital property, or has a taxable capital gain. For property other than capital property, we have to consider any election under subsection 25(1) or 99(2) that extends the fiscal period of either an individual proprietor who disposed of a business, or an individual member of a terminated partnership.
13. The parties to an election have to provide all the information required by the forms, obtain the appropriate signatures, and pay any late-filing penalties when filing the forms. All parties should ensure that they file their election on the most recent version of the prescribed form (available from their tax services office).
14. The relevant forms provide more details on filing requirements.
LATE AND AMENDED ELECTIONS
15. Under subsection 85(7), you can make an election up to three years after the filing deadline referred to in paragraph 12. Subsection 85(7.1) provides that you can file an election more than three years after the original due date, or amend an election at any time if, in the opinion of the Minister, the circumstances giving rise to the late or amended election are just and equitable. The Minister delegates the authority to accept these late and amended elections to the directors of tax services offices. You or your representative should file a late or amended election, provided under subsection 85(7.1), at the transferor's tax services office, together with a written request to the Minister to accept the election. The request should provide the reasons why you consider that it is just and equitable to accept the election. If you do not include these reasons, the Department will not process the election. You also have to pay an estimate of the applicable penalty when making the election (refer to paragraph 21).
16. We will generally accept an amended election under subsection 85(7.1) if its purpose is to revise an agreed amount, and without this revision, there would be unintended tax consequences for the taxpayers involved. We will permit revisions to correct an error, omission, or oversight made at the time of the original election. However, we will not permit revisions when, in the Department's view, the main purpose of the amended election is:
- retroactive tax planning, such as taking advantage of losses or tax credits not considered when the election was originally filed. In situations where the changes are partly retroactive tax planning and partly to correct errors, we will advise you that we will only accept an amended election for the latter;
- to take advantage of amendments in the law enacted after the original election was filed, e.g., an increase in the agreed amount of an election made in April 1985 to create a capital gain that may be offset by a capital gains deduction under section 110.6;
- to improperly avoid or evade tax; or
- to change the agreed amount in a statute-barred year.
17. The Department will accept an amended election only if you or your representative originally filed a valid election under subsection 85(1) or (2). For example, if, in the original election, consideration received by the transferor does not include at least one (or a fraction of one) share, it will not be a valid election.
18. Revenue Canada will generally accept an amended election when:
- it corrects an inaccurate property valuation that gave rise to unintended tax consequences;
- it reduces the agreed amount of transferred shares to the correct cost amount when a transfer at cost was the intention, e.g., subsection 83(1) dividends were omitted when calculating their adjusted cost base;
- it corrects situations where it is clear that an amount was inserted in error, such as the transfer of depreciable property at its net book value instead of its undepreciated capital cost; and
- it corrects other situations which resulted in unintended tax consequences, e.g., the application of section 84.1, subsections 15(1), 84(1), and 85(2.1), or paragraph 85(1)(e.2), when it is clear the parties wanted the rollover without any immediate tax consequences.
AMENDED ELECTION NOT REQUIRED
19. The Department will correct clerical errors without requiring an amended election. We will consider transposition or typographical errors as clerical errors only if they are obvious upon our initial review of the election form. We will not consider as a clerical error a situation where the agreed amount equals the fair market value of the property at the time of transfer.
20. Paragraphs 85(1)(b), (c), (c.1), (c.2), (d), (e), (e.2), (e.3), and (e.4) automatically adjust the agreed amount of the transferred property. In such cases, you do not have to file an amended election. However, we will need an amended election if you want to avoid the tax consequences resulting from the automatic adjustment to the agreed amount, subject to the comments in paragraphs 15 to 18 above.
PENALTY FOR LATE AND AMENDED ELECTIONS
21. The Department does not accept an amended or late-filed election made under subsection 85(7) or (7.1), unless the transferor calculates and pays the estimated penalty when filing the election. We will subsequently determine and assess the balance of the penalty the transferor has to pay without delay. If we accept a late or amended election, the penalty, calculated pursuant to subsection 85(8), is the lesser of:
- (a) one-quarter of 1% of the excess of the property's fair market value at the time of the disposition over the agreed amount for each month or part of a month after the election's original due date and before the filing of the late or amended election; and
- (b) $100 for each month or part of a month referred to above, to a maximum of $8,000.
22. The penalty described in paragraph 21 is subject to the provisions of subsection 220(3.1). For details on the cancellation or waiver of any penalty, see Information Circular 92-2, Guidelines for the Cancellation And Waiver Of Interest And Penalties.
BENEFIT CONFERRED ON A RELATED PERSON
23. Paragraph 85(1)(e.2) prevents you as the taxpayer from using subsection 85(1) to confer a benefit on a person related to you. If the fair market value of the transferred property immediately before the disposition exceeds the fair market value of all the consideration taken back, the agreed amount will be increased by the portion of this excess that can reasonably be regarded as a benefit conferred on a person related to you. This rule applies except for the purpose of determining the cost to you of the shares of the transferee corporation you received as consideration for the transferred property. Transfers to a corporation that was a wholly owned corporation of the taxpayer immediately after the disposition will not be subject to paragraph 85(1)(e.2) "benefit conferred to a related person." In these circumstances no benefit will be considered to have been conferred even though the fair market value of the transferred property exceeds the fair market value of the consideration received. Subsection 85(1.3) defines the term " wholly owned corporation."
24. The potential deferred tax liability in the hands of the transferee does not reduce the fair market value of the transferred property. You should consider this when you determine the amount of consideration that has to be taken back to ensure that paragraph 85(1)(e.2) does not apply. Generally, we will not apply paragraph 85(1)(e.2) when you satisfy all the following conditions:
- the transferor takes back retractable preference shares having a retraction amount equal to the fair market value of the transferred property less any other consideration taken back;
- the net fair market value of the transferee corporation is not less than the retraction amount of the retractable shares immediately after the transfer; and
- the rights, conditions, and characteristics of the shares are such that they maintain their value until they are redeemed.
For clarification purposes, "retractable shares" are shares that are redeemable at the option of the holder.
DEEMED DIVIDENDS AND APPROPRIATIONS
25. A person transferring property to a corporation shall receive consideration which includes shares, or a fraction of a share, of a class of the capital stock of that corporation. This transfer may result in an increase in paid-up capital that is more than the increase in the value of the corporation's net assets. In such a situation, for property disposed of before November 22, 1985, all the shareholders of that class of shares are deemed to have received a dividend according to subsection 84(1). After November 21, 1985, when the taxpayer transfers property to a corporation under subsection 85(1) or (2), and the paid-up capital of the share consideration is greater than the cost to the corporation of the property (less the fair market value of any non-share consideration), subsection 85(2.1) will apply to reduce the paid-up capital of the shares by the amount of the excess. As a result, we will take into account the reduction in paid-up capital under subsection 85(2.1) in determining the amount of any deemed dividend under subsection 84(1) for the same transaction. In such situations, where the total fair market value of the consideration is more than the fair market value of all the properties transferred, subsection 15(1) applies, except for any amount that was already included in income under subsection 84(1). For more details and examples, see IT-432, Benefits Conferred on Shareholders, and IT-291, Transfer of Property to a Corporation under Subsection 85(1). For information concerning paid-up capital, refer to IT-463, Paid-up Capital.
PRICE ADJUSTMENT CLAUSES
26. IT-169, Price Adjustment Clauses, states the conditions under which the Department will recognize a price adjustment clause for property transferred in a non-arm's-length transaction. However, a price adjustment clause does not automatically amend a section 85 election. In order to give effect to a price adjustment clause, you have to file an amended election under subsection 85(7.1). An acceptable price adjustment clause has to adjust the price of the property transferred and the consideration received, not the quantity of the property transferred. The terms "amount" and "fair market value" in section 85 must be interpreted as fixed and specific dollar figures at the date of transfer, not formulas that can determine or adjust an amount later. A price adjustment clause cannot change these figures retroactively.
LOSSES FROM DISPOSITION OF PROPERTY TO A CONTROLLED CORPORATION
27. Generally, you cannot claim an allowable capital loss or a terminal allowance (i.e., the deduction of your cumulative eligible capital) if it arises on a transfer to a corporation and, immediately after the transfer, the corporation was controlled directly or indirectly by the taxpayers described in subsection 85(4) - see IT-291, Transfer of Property to a Corporation under Subsection 85(1). This restriction on losses applies on a property-by-property basis. Consequently, losses and gains on properties transferred at the same time may not be offset.
28. In certain cases, you will be unable to obtain a tax-free distribution of a pre-1972 gain as a result of a transfer under section 85. For example, if the fair market value of depreciable property at December 31, 1971, is more than the actual cost of the property, and an individual transfers the property to a corporation under section 85 at less than the fair market value at December 31, 1971, no 1971 capital surplus (or, after 1978, pre-1972 capital surplus) will arise if the corporation later disposes of the property at more than its actual cost. For more details, see IT-132, Capital Property Owned on December 31, 1971 - Non-Arm's Length Transactions.
FACSIMILE ELECTION FORMS
29. The Department may permit facsimile forms if you obtained prior written consent from the:
25 Nicholas Street
Ottawa ON K1A 0L5
You should send a copy of the proposed facsimile form with your submission to the Department at least 60 days before the electors have to sign the forms. For more comments on facsimile forms, see Information Circular 92-5, T1, T2 and T3 Customs Returns.
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