Differentiating Tax Strategies: Sec. 85 vs. Sec. 87

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

Both Section 85 and Section 87 of the Income Tax Act (Canada) provide variants of tax-deferred reorganizations (rollovers), which aim to defer immediate tax consequences that would otherwise arise from a transfer of property, they apply to vastly different types of corporate transactions and involve distinct mechanisms. The core difference lies in their scope and nature: Section 85 is an elective provision for the transfer of specific property from a taxpayer to a corporation, whereas Section 87 is an automatic rule governing the merger of two or more corporations into a single new entity (amalgamation).

Nature of the Transaction and Deferral Mechanism: The most significant distinction lies in the type of transaction each section governs. Section 85 governs a specific transfer of eligible property (like capital property, inventory, or resource property) from an eligible transferor (individual, partnership, trust, or corporation) to a taxable Canadian corporation. This transfer is executed through a joint election (Form T2057 or T2058) by the transferor and the corporation, allowing them to fix an "elected amount" as the proceeds of disposition and the new cost base. This elected amount is typically set at a value that defers the recognition of any accrued gain, hence the term "rollover." In stark contrast, Section 87 is an automatic rollover (no election is required) that applies to a statutory amalgamation of two or more predecessor corporations into a single new corporation. This transaction is a corporate law concept where the predecessor corporations cease to exist, and the new amalgamated corporation is a continuation of all their assets and liabilities. The purpose is not merely to transfer an asset, but to legally and fiscally merge entire corporate entities into one.

Parties Involved and Consideration Received: The parties involved in each transaction are another key point of differentiation. A Section 85 rollover requires two distinct parties: an eligible transferor (who can be any taxpayer) and a taxable Canadian corporation (the transferee). The consideration received by the transferor must include shares of the transferee corporation, but can also include other forms of consideration, often called "boot" (e.g., cash or debt). The presence of boot can be used to set the elected amount and trigger a minimum amount of taxable gain if desired. Section 87, conversely, involves the predecessor corporations and their shareholders. All predecessor corporations must be taxable Canadian corporations. For the rollover to apply, the shareholders of the predecessor corporations must receive shares of the new amalgamated corporation, and no other consideration (boot) can be received in exchange for their old shares. This rigid restriction ensures the transaction is a pure continuance of the equity interest in the combined business.

Scope and Flexibility: Section 85 offers significant flexibility as a tax planning tool. It is property-specific, allowing a taxpayer to pick and choose which assets to transfer to a corporation and at what elected amount (within statutory limits). This makes it ideal for transactions like incorporating a sole proprietorship, crystallizing an individual's capital gains exemption, or internal asset transfers between related entities. The elected amount is the primary mechanism for controlling the tax outcome. Section 87 is far less flexible in its application, as it is an "all or nothing" provision relating to the corporate structure itself. If a statutory amalgamation occurs and the conditions are met, the rollover is mandatory and applies to all assets and liabilities of the predecessor corporations. It is a corporate-level transaction intended for structural simplification, mergers, or acquisitions where the legal entities are being combined. It's important to note that, under Section 87, the new corporation generally succeeds to the tax attributes (such as Non-Capital Losses, tax pools, and cost basis) of the predecessor corporations, a comprehensive carry-over that is beyond the scope of a property-by-property Section 85 transfer.

Tax Administration and Filing Requirements: The administrative and filing requirements are also fundamentally different. The Section 85 rollover is not automatic; it requires the timely filing of the prescribed election form (T2057 or T2058) by both the transferor and the corporation. Failure to file, or filing incorrectly, can result in the transfer occurring at Fair Market Value (FMV), triggering immediate and potentially disastrous tax consequences, including penalties for late elections. In contrast, the Section 87 amalgamation is a statutory deeming rule. If the corporate law and Income Tax Act conditions for amalgamation are met, the tax deferral is automatic; no separate tax election form is required to effect the rollover of assets or shares. However, a crucial aspect of an amalgamation is the deemed year-end of the predecessor corporations immediately before the merger, necessitating the filing of terminal tax returns for each of them.

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).

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