If you have been running a business for a while now, you may have considered incorporating it. However, this process involves rolling your sole-proprietorship or partnership into the newly formed corporation. Before you take this step, there are several things you need to consider.
One important consideration is the tax implications of this process. The Canada Revenue Agency (CRA) views this as a business sale, even though you own the corporation. Whenever there is a transaction in Canada, there is a tax event. This may not always be taxable, but it requires thoughtful consideration.
If the tax event generates a profit or capital gain, the CRA will get their share. Even if you think you can sell your business to the company for a dollar, there are rules in the Income Tax Act that ensure related parties deal with each other at fair market prices. This means transactions are deemed to occur at a fair market price, as if you were dealing with a non-related party. Deemed, in this case, means a pretend or forced number, and you may not like the result.
The CRA will be looking for ways in which your business is more valuable than you think, as they are motivated to maximize the amount of tax they collect from taxpayers within the letter of the law. They may look at the goodwill of your business, which is an average of your business’s income levels over the years, and apply a multiple.
The good news is that there is a section of the Income Tax Act that allows you to roll your business into the company without triggering any tax bill. This is called a subsection 85 Rollover. Your CPA and your lawyer will know what this means and can help guide you through the process. However, it does complicate the process for both the CPA and lawyer, which means additional fees.
In summary, rolling your business into a small business corporation is not a simple process. You need to consider the tax implications and understand the CRA’s perspective on this matter. There is a subsection 85 Rollover that allows you to avoid triggering a tax bill, but it can complicate the process and result in additional fees. If you’re considering incorporation, talk to a CPA and a lawyer who can guide you through the process and help you make the best decisions for your business.
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Check out our video on Rolling Your Business Into a Corporation using Subsection 85 Rollover
