How A Sole Proprietor Can Defer Capital Gains Tax

As a sole proprietorship, when you are transferring assets to a corporation, you would usually pay capital gain tax on the difference between the fair market value of the asset and its purchase price. CRA requires the asset to be sold to the corporation.

black Android smartphone near ballpoint pen, tax withholding certificate on top of white folder
Credit: Kelly Sikkema

Say I’m selling my customer list to a corporation for $50,000. Because there is no purchase price (I built it from $0), the gain is $50,000 and I would have to pay capital gain tax on this.

This can become quite costly when you are transferring a lot of assets. To avoid this, in certain cases you can utilize the section 85 rollover, whereby the asset is sold to the corporation at its purchase price.

This is only suitable for assets like capital properties, intangible assets, and inventory, where there is an accumulated capital gain on them. Other assets like accounts receivable and assets with losses are not suited for this.

The rollover allows you to transfer the assets at their purchase price to the corporation instead of selling it to them at fair market value. This bypasses any capital gains tax.

But the following conditions need to be met.

  • The corporation must be incorporated in Canada
  • You must receive at least one share from the corporation
  • What you get back must be equivalent to the fair market value of the asset you transferred.

Let’s break that down with an example.

Frank has decided to transfer an asset (listed below) to a Canadian incorporated corporation (whose shares are worth $5 each):

Frank is transferring:

Inventory
FMV: $43,000
(Purchase Price: $18,000)

In exchange for:

Shares
4000 at $5 each
Total value: $20,000

Cash
$23,000

Total value of shares and cash is $43,000 ($20,000 shares+$23,000 cash)

Frank can do this because he is receiving at least 1 share back, he’s getting back $43000 worth of assets in exchange for his inventory (FMV of $43,000), and he’s dealing with a Canadian corporation. By using the section 85 rollover, Frank avoids paying capital gains tax on $12500 for his inventory [ (43,000-18,000)/2].

IDM Professional Corporation has strong experience in tax planning for companies and can help your company transition into growth in a tax effective way.