Section 85 Corporate Rollover
Branch - Subsidiary - Incorporation - Partnership - Joint Venture - License - Franchise
For international commercial enterprises requiring Canadian legal services call 403-400-4092 or email Chris@NeufeldLegal.com
A Section 85 corporate rollover serves as a vital mechanism for deferring the tax consequences that would normally arise when transferring business assets. Under the general rules of the Income Tax Act (Canada), a transfer of property is typically treated as a sale at Fair Market Value, which can trigger immediate capital gains or recapture of depreciation. Section 85 provides "rollover" relief, allowing the transferor and a taxable Canadian corporation to jointly elect an "agreed amount" for the transfer, effectively shifting the tax liability to a future date when the assets are eventually sold to a third party.
This process is utilized in the transition of a Canadian branch (operated by an international business enterprise) into a domestic subsidiary corporation. Where the international business enterprise has initially operated in Canada as a branch to offset start-up losses against global income; yet, as the branch becomes profitable and grows in complexity, the parent company may wish to "subsidiarize" the operations to limit liability, simplify compliance, or optimize for the Part XIV branch profits tax. In this transition, the foreign parent (the transferor) moves the branch’s assets (such as equipment, inventory, and intangible goodwill) to a newly formed Canadian subsidiary (the transferee).
To qualify for this deferral, the consideration received by the foreign parent must include at least one share of the new subsidiary’s capital stock. While "boot" (non-share consideration like cash or a promissory note) can be included, the tax-deferred nature of the transaction depends on the agreed amount chosen in the joint election. For a branch-to-subsidiary conversion, the parties typically elect an amount equal to the tax cost of the assets (their Adjusted Cost Base or Undepreciated Capital Cost). This ensures the parent realizes no immediate gain, while the subsidiary inherits the same tax cost for the assets.
The complexity of such a transition often lies in valuing intangible assets, particularly goodwill. Over years of operation, a Canadian branch may have built significant brand value and customer loyalty that does not appear on its balance sheet. Without a Section 85 rollover, the Canada Revenue Agency would deem this goodwill to have been sold at its current market value, potentially resulting in a massive tax bill for the foreign parent. By using the rollover, this "earned goodwill" can be transferred at a nominal cost, preserving the parent company's cash flow for further investment in the Canadian market.
Beyond immediate income tax deferral, converting a branch to a subsidiary through Section 85 addresses the unique burden of Branch Profits Tax. Foreign corporations carrying on business in Canada directly are subject to an additional tax on their after-tax profits not reinvested in the branch. By moving these operations into a subsidiary, the foreign parent replaces the annual branch tax calculation with a standard withholding tax regime on dividends. This provides more control over the timing of Canadian tax payments, as withholding tax is only triggered when profits are actually repatriated as dividends.
As such, when your international business seeks the professional services of an experienced Canadian business lawyer to facilitate its entry into Canada's commercial market, contact our law firm for a confidential initial consultation at 403-400-4092 [western Canada], 905-616-8864 [eastern Canada] or Chris@NeufeldLegal.com.