How to Incorporate Your Business without Adverse Tax Impact

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How to Incorporate Your Business without Adverse Tax Impact

Incorporating your business

After a small business has grown large enough within the definition of a sole proprietorship or a partnership, it must consider its road ahead. The decision to have your business incorporated is generally always a difficult one, but a necessary ‘first step’ that absolutely must be taken. And, that makes complete sense when you consider a corporation comes with unbelievable benefits over being a sole proprietor. For instance, you are protected of your liabilities; you receive necessary tax deductions, etc. but, the transition to a corporation isn’t quite easy and harmless.

All tax specialists would warn you when proceeding to incorporate your business that proper preparation and planning is a must. Not doing so leaves you vulnerable to adverse tax impacts. Tax specialists, however, would also help you with the necessary information required to help your important transition. The primary problem with incorporating your business is the risk of a capital gain liability, which can occur when possible gain is accrued whilst the transfer of assets from the company to the corporation. But, that can also be negated when it’s done properly through preparation and planning.

Section 85 Rollover

While properties are being transferred, if the transferor and the transferee opt to make a joint tax election, it is an application of Section 85 Rollover. Entrepreneurs can successfully defer payment of tax when this section is applied. The problem with not applying the Section, in the words of reputed tax specialists, is that these same properties are considered to be sold at fair market value by the company, which can then lead to a capital gain. When Section 85 is applied, entrepreneurs can easily avoid incurring a capital gain tax liability until the time of the asset actually sold off.

Relevant Technical Requirements

To be able to successfully utilize Section 85 for your benefit, listed below are the essential requirements. These requirements essentially act as criterions that absolutely must be met.

Eligible Transferor

Only an eligible transferor can apply for Section 85. And, you must qualify as an eligible transferor under the rule set forth by the Income Tax Act. As per the definition of an eligible transferor, any taxpayer, in the form of an individual, a trust, or a corporation is be eligible to apply for Section 85.

Eligible Transferee

Just like the transferor must be eligible to apply for Section 85, the transferee must also be eligible to apply for the section. The only entity eligible to apply for the section is a “Taxable Canadian Corporation”, which essentially means it is a corporation and it is a resident of Canada. This leaves out all partnerships, all individuals, and all trusts from the election of Section 85 as a transferee. Besides, the transformation to a corporation is the entire premise of incorporating your business. Hence, we see no reason why a transferee should be an individual, a partnership, or a trust.

Eligible Property

While making sure the eligibility of the transferee and the transferor, it only makes sense to verify the eligibility of the transferable property in question. Not all properties can be eligible for the rollover. Here’s a brief description of the eligible and non-eligible properties under the requisite Act.

Eligible Properties

Listed below are the types of properties that are eligible for the section 85 rollover:

  • All capital properties, regardless of the fact that the property is depreciative in nature, qualify for the election of Section 85
  • All intangible properties are also eligible for a rollover. These properties include abstract ones such as goodwill, customer base, and intellectual properties such as trade secrets, patents, trademarks, etc.
  • All kinds of fixed inventory also qualify for a transfer

Ineligible Properties

  • While we’re listing ‘accounts receivable’ under the’ ineligible properties’ section, that’s not necessarily accurate. In certain situations Section 22 may be more appropriate and not Section 85. Depending on the situation Section 22 is more suited to serve your needs when you’re in the process of incorporating your business
  • While depreciative assets are also eligible for a transfer, that doesn’t apply to assets that are visibly going to end up in a terminal loss
  • Other depreciative assets that are excluded from the rollover are those depreciative assets that suffer an accrued capital loss

Considerations

It’s essential for a party to provide some consideration to the other in return for the undertaking of the exchange. This technical requirement makes it important that a certain share of the capital stock (in the newly formed corporation) is received by the transferor. This share is simply a token that signifies the previous transfer of property.

Elected Transfer Price

The entire premise of opting for Section 85 during the process of incorporating your business is to prevent any gain on the newly transferred property. The only way to prevent reporting capital gain on this transfer is through valuing the property equal to the incurred costs. According to tax specialists, that’s the best way to achieve substantial deferral of gain.

Others who intend to use Section 85 for planning their taxes must understand that the amount of the elected transfer price must be subjected to these limitations:

  • The transfer price of the property in question must not exceed its prevalent ‘fair market value’
  • The transfer price of the property in question must not be lesser than the prevalent ‘fair market value’, or its cost in terms of tax
  • And lastly, the transfer price of the property must not be lesser than the fair market value of the non-share consideration. This ‘non-share consideration’ is referred to as ‘boot’ and it includes cash or the amount of the loan payable.

Section 85 makes a tremendous difference as it virtually eliminates the entire question of suffering a capital gain on the transfer of property. The application of Section 85, however, can be a complicated procedure, and that’s precisely why you need the services of a knowledgeable tax specialist firm such as Altitude Accounting. With a team that consists of tax specialists, we have helped quite a few of today’s successful corporations achieve this success. Contact us to understand what we can do for you.

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