Differentiating Tax Strategies: Sec. 85 vs. Sec. 51(1)

Neufeld Legal: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

Differentiating between Section 85 and Subsection 51(1) of the Income Tax Act (Canada) focuses primarily on the scope of property transferred, the transaction structure, the necessity of an election, and the receipt of non-share consideration ("boot"). Both statutory arrangements are critical "rollover" mechanisms that allow a taxpayer to defer or postpone immediate tax consequences on the disposition of property, but they serve distinct corporate and tax planning purposes.

Scope and Nature of the Transaction: Section 85 is a broad provision that facilitates the transfer of eligible property from a taxpayer (an individual, corporation, or trust) to a taxable Canadian corporation. The eligible property is extensive, including both depreciable and non-depreciable capital property, inventory, and resource properties. The core transaction involves a transfer of these diverse assets to a corporation in exchange for consideration that must include shares of the transferee corporation. This mechanism is frequently used to incorporate a business or restructure a corporate group by moving assets between related entities. In contrast, Subsection 51(1) is a narrower, more automatic rollover applying only to the conversion of specific convertible property into shares of the same corporation. The convertible property is strictly defined as a capital property that is a share, bond, debenture, or note of the corporation, the terms of which confer on the holder the right to make the exchange. The transaction is essentially an internal capital restructuring, such as a shareholder converting common shares into a new class of preferred shares, or converting a convertible debt instrument into equity.

Election Requirement and Mechanism of Deferral: A key structural difference is the requirement for an election. A Section 85 rollover is elective and requires the transferor and the transferee corporation to jointly file a prescribed form (Form T2057 or T2058). By electing, the parties agree on a specific "elected amount" for the transfer, which becomes the transferor's proceeds of disposition and the corporation's cost of acquisition. This elected amount can be chosen to be anywhere between the property’s cost amount (or adjusted cost base, ACB) and its fair market value (FMV), allowing the taxpayer to control the level of tax deferral or even to purposefully trigger a capital gain (known as "crystallization"). Conversely, the rollover under Subsection 51(1) is automatic and requires no joint election or filing of a prescribed form. If all the conditions of the section are met, primarily involving a valid exchange of convertible property for shares of the same corporation with no other consideration received, the transaction is deemed not to be a disposition. This automatic application simplifies the process but offers no flexibility in setting a specific proceeds amount; the ACB of the original property is automatically carried over to the new shares received.

Consideration Received ("Boot" Allowance): The rules regarding consideration received are one of the most critical distinguishing factors. Section 85 is designed to permit the receipt of non-share consideration, commonly referred to as "boot" (e.g., cash, a promissory note, or other property) along with the required shares. The inclusion of boot allows for greater transactional flexibility, for example, enabling a taxpayer to extract tax-free cash up to the tax cost (ACB) of the transferred property. However, the elected amount must be at least equal to the fair market value of this non-share consideration, meaning any boot received in excess of the property's ACB will typically trigger an immediate capital gain up to the amount of that excess. Subsection 51(1), in almost all cases, strictly prohibits the receipt of non-share consideration. The taxpayer must receive only shares of the corporation in exchange for the convertible property (a minor exception exists for cash received in lieu of a fractional share). The moment the taxpayer receives any other form of consideration, the transaction fails to qualify under Section 51(1), and the taxpayer would need to rely on Section 85 or Section 86 (Statutory Amalgamation/Reorganization) if a rollover is still desired, which would then necessitate the joint election and complexity of those other provisions.

Overall Purpose and Utility: Fundamentally, the two sections serve different planning objectives. Section 85 is a powerful corporate finance and restructuring tool that enables tax-deferred transfers of a wide range of business and investment assets into a corporation. Its primary uses include incorporating sole proprietorships, performing corporate reorganizations involving asset transfers between related companies, and crystallizing the capital gains exemption before a sale. The need for an election and the flexibility to use "boot" make it suitable for complex, bespoke transactions where specific tax and financial outcomes are desired. Subsection 51(1), by contrast, is a simple and automatic capital structure management tool used for internal changes to a corporation's share capital, such as converting one class of share to another (e.g., in an estate freeze), or exercising a conversion right on a debt instrument. Its simplicity (no election form) and rigid rules (no boot) make it ideal for routine, clean conversions that do not involve bringing in new property to the corporation or taking out cash/debt.

While both Section 85 and Subsection 51(1) are tax-deferred rollover provisions, the Section 85 is a flexible, elective tool for the transfer of diverse assets to a taxable Canadian corporation, permitting the use of non-share consideration. Meanwhile Subsection 51(1) is an automatic, non-elective tool for the conversion of specific equity/debt within the same corporation, strictly prohibiting most forms of non-share consideration.

For knowledgeable and experienced tax law representation for corporate tax rollovers and other tax planning strategies, as your business enterprise strives to optimize the financial advantages of legal tax structuring, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

Differentiating: Sec. 85 vs. Sec. 85.1  |  Sec. 85 vs. Sec. 86  |  Sec. 85 vs. Sec. 87  |  Sec. 85 vs. Sec. 51(1)

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