If you are incorporating a partnership or a sole proprietorship, you will likely transfer assets. When you do that, take precautions so you don’t pay too much in taxes.
The transfer of physical assets into a corporation is considered a disposition at fair market value (FMV). You cannot assign little or no value to the assets. If you do, Canada Revenue Agency can later determine that you not only owe taxes but also must pay penalties and interest. Transfers of assets can generate gains or losses, and the tax treatment depends largely on whether the property has been previously used in a business.
Gains: The transfer of assets that were not previously used in a business will generally produce capital gains, in which case fifty per cent of the difference between FMV and the original cost will be taxable income.
In cases where the property had already been used in a business, the transfer is taxed in two steps:
1. The gain is first accounted for as a recapture of previously claimed Capital Cost Allowance (CCA) and taxed as business income.
2. If the FMV of the asset exceeds the original purchase price plus improvements, the excess will be a capital gain.
Losses: If an asset was not already used in a business, a loss from the transaction won’t be deductible because it will be considered a loss on a personal-use asset.
Property that was used in a business can generate two types of losses, depending on the nature of the asset. For example, land will produce a deductible capital loss while buildings vehicles, equipment or tools will produce a terminal loss.
Stop-loss rules may apply when transferring assets. Consult with your accountant before transferring any assets.
Section 85 Elections: To avoid taxes immediately on asset transfers, you can make an Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation. This allows many, although not all, assets to be transferred to a corporation without triggering taxes.
The corporation is deemed to have acquired the assets at the original cost and to have taken Capital Cost Allowance in prior years. If the corporation later disposes of the assets, it will add the CCA recapture to income and either pay a capital gains tax, deduct a terminal loss or claim a capital loss, depending on the situation.
The Excise Tax Act allows for a tax-free transfer of the assets of one business to another, as long as both are GST/HST registrants. You must file an Election Concerning the Acquisition of a Business or Part of a Business.
Personal assets not used for business purposes before transferring them to a corporation or using them in a proprietorship aren’t subject to GST/HST on the transfer. These assets may qualify for input tax credits when the business starts to use them. The most common example of this is when you start to use your personal vehicle for commercial purposes.
The tax implications of asset transfers can be complicated. Talk to your accountant about the transaction before you incorporate. Waiting until it’s time to file a tax return could cost you money.