Business Valuation and Tax-Free Rollovers: Key Insights
Overview of Sections 85 to 88:
These sections of the Canadian Income Tax Act allow taxpayers to defer the recognition of gains when transferring assets to a corporation or reorganizing their business, ensuring that taxes are not triggered immediately. However, a proper valuation is essential to comply with legal and tax requirements.Why Business Valuation is Necessary:
Determining Fair Market Value (FMV):
- Valuation establishes the FMV of the assets or shares being transferred.
- Accurate FMV ensures that the transfer follows tax regulations and avoids challenges from the Canada Revenue Agency (CRA).
Documenting the Elected Transfer Price:
- The elected price must fall between the asset’s adjusted cost base (ACB) and its FMV to qualify for a tax-free rollover.
- A valuation provides the necessary documentation to set this price correctly.
Avoiding CRA Scrutiny:
- The CRA closely reviews tax-free rollovers to ensure FMV is accurately assessed.
- A professional valuation mitigates the risk of reassessment, penalties, or disputes.
Supporting Legal Agreements:
- Valuation is often required to draft the necessary agreements, such as Section 85 election forms (T2057 or T2058).
- These agreements must detail the value of the assets or shares being transferred.
Specific Scenarios Requiring Business Valuation:
Section 85 – Transfer of Assets to a Corporation:
- Applies when an individual or partnership transfers assets to a corporation in exchange for shares.
- Valuation is essential to determine the FMV of both the transferred assets and the shares issued in return.
Section 86 – Share Reorganizations:
- Used when reorganizing the share structure of a corporation, such as exchanging common shares for preferred shares.
- Valuation ensures the FMV of the new shares aligns with the FMV of the old shares to maintain tax deferral.
Section 87 – Corporate Amalgamations:
- When two or more corporations merge, the FMV of the shares and assets of the pre-existing corporations must be determined.
- Valuation ensures proper allocation of shares in the new amalgamated entity.
Section 88 – Corporate Wind-Ups:
- In a wind-up scenario, the FMV of the remaining assets must be established for distribution to shareholders.
- Proper valuation ensures accurate tax reporting and compliance with CRA requirements.
Benefits of Professional Valuation in Tax-Free Rollovers:
- Legal Compliance: Ensures adherence to the Income Tax Act, reducing the risk of errors.
- CRA Defense: Provides robust documentation to support the transaction in case of a CRA review.
- Strategic Planning: Helps optimize the elected price for tax deferral while maintaining flexibility for future transactions.
- Accurate Record-Keeping: Serves as an official record for both the taxpayer and CRA.