Section 85 Rollover Valuations: Getting Fair Market Value Right

A section 85 rollover is one of the most used provisions in the Income Tax Act for owner-managed businesses. It lets you move eligible property into a taxable Canadian corporation without triggering an immediate tax bill, which is why it sits underneath so many incorporations, holding company reorganizations, and estate freezes. The mechanics run through a joint election, but the entire structure rests on one number: the fair market value of what you transferred. Get that number wrong, or fail to support it, and a transaction designed to defer tax can create it instead.

Our corporate finance and business valuation team prepares the fair market value support that sits behind these elections. This article explains where value drives the rollover, what the Canada Revenue Agency expects to see, and when a formal valuation is worth the cost.

What a Section 85 Rollover Does

Under section 85, a taxpayer transfers eligible property, such as shares, goodwill, real property used in a business, or intellectual property, to a taxable Canadian corporation and takes back consideration that must include at least one share of that corporation. The transferor and the corporation jointly file Form T2057 (Form T2058 where a partnership transfers) and elect an agreed amount that becomes the proceeds for the transferor and the cost to the corporation.

The elected amount is what makes the deferral work, and it is not a free choice. Broadly, it cannot exceed the fair market value of the property transferred, it cannot be less than the value of any non-share consideration you take back, and it is subject to floors tied to the tax cost of the property. Every one of those boundaries is measured against fair market value. That is the reason a rollover file always contains a valuation question, whether or not anyone has answered it.

A Price Adjustment Clause Is Not a Substitute for a Valuation

Most rollover agreements include a price adjustment clause, which adjusts the consideration if CRA ultimately determines a different fair market value. Practitioners sometimes treat the clause as insurance that makes valuation work unnecessary. CRA’s published position, set out in Income Tax Folio S4-F3-C1, points the other way: the Agency will generally recognize a price adjustment clause only where the parties made a genuine effort to determine fair market value using a fair and reasonable method at the time of the transaction.

In other words, the clause protects taxpayers who did real valuation work and turned out to be somewhat off. It offers much weaker comfort to taxpayers who picked a number and hoped. A defensible valuation is what activates the protection the clause is supposed to provide.

Why the Value Has to Be Right

If CRA later concludes the fair market value was different from what the parties assumed, the consequences reach beyond a simple adjustment. Non-share consideration above the property’s tax cost can trigger immediate income. Where the transfer confers a benefit on a related shareholder, the elected amount can be adjusted under the benefit rules in section 85, which can produce double taxation with no offsetting relief. Paid-up capital and cost base calculations flow from the same numbers, so an error compounds through every later transaction involving those shares.

These are not theoretical outcomes. Value disputes tend to surface years later, on audit or on a subsequent sale, when the planning memory has faded and the burden of supporting the original number falls on documentation prepared at the time. A file that shows a serious, contemporaneous valuation is a very different starting point from a file that shows a number chosen to make the election work.

Where We See Section 85 Valuations in Practice

The situations that put a rollover valuation on our desk repeat themselves. An unincorporated business incorporates after several profitable years and needs goodwill valued. A shareholder moves an operating company under a new holding company. An estate freeze exchanges common shares for fixed-value preferred shares, with section 85 or section 86 doing the mechanical work and the freeze value needing support. An owner crystallizes the lifetime capital gains exemption. Intellectual property or other assets move between related companies, which is exactly the kind of transfer where CRA expects to see how an arm’s length price was established.

In each case the tax plan comes from your accountant or tax lawyer. What we add is the independent conclusion of value that the plan relies on, prepared by a Chartered Business Valuator and documented so it can be handed to CRA as filed support.

What the File Should Contain

Valuation support for a rollover does not need to be the same depth for every transfer. A modest transfer of assets with observable market comparables needs less than a freeze of a profitable operating company with significant goodwill. What the file should always show is an identifiable valuation date matching the transfer, a recognized approach applied to the facts, the key assumptions and their basis, and a conclusion expressed clearly enough that the elected amount and share terms can be tied to it. Timing matters as well. The election is due with the earliest tax return deadline of the parties for the year of the transfer, and late-filed elections attract penalties that grow monthly, so the valuation should be complete before the T2057 is prepared, not reconstructed afterward.

How KitsWest Capital Helps

KitsWest Capital is a corporate finance and business valuation firm in Vancouver serving owner-managed businesses across BC and Alberta. Our CBV-led valuations are prepared at the level of depth the transaction warrants, with fixed fees quoted before we start, and we work directly with your accountant or tax counsel so the valuation, the election, and the share terms line up. The first step is a short, confidential call about the transfer you are planning.

Frequently Asked Questions

Do I Need a Formal Valuation for a Section 85 Rollover?

There is no statutory requirement to attach a valuation report to the election. There is a practical requirement to be able to support the fair market value you used, because every limit in the election is measured against it. The more value sits in goodwill, intellectual property, or other hard-to-price assets, the stronger the case for independent support.

What Happens if CRA Disagrees With the Value We Used?

CRA can adjust the elected amount within the statutory limits, which can create immediate income, benefit issues between related parties, and in some cases double taxation. Contemporaneous valuation support is the primary defence, and it also determines whether a price adjustment clause will be respected.

We Have a Price Adjustment Clause. Is That Enough?

On its own, usually not. CRA’s position in Folio S4-F3-C1 is that the clause is recognized where the parties made a genuine attempt to determine fair market value by a fair and reasonable method. The clause works alongside a valuation, not instead of one.

When Does the Election Have to Be Filed?

Form T2057 is due on or before the earliest date on which any party to the election has to file a return for the year of the transfer. Late filing is possible for a period afterward, with a monthly penalty, and beyond that only at CRA’s discretion. Valuation work should be finished before the deadline, not after.

Do You Work With Our Existing Accountant?

Yes. Rollover valuations are collaborative by nature. Your accountant or tax lawyer structures the election, and we provide the independent value conclusion the structure depends on. We are regularly retained directly by CPA firms for exactly this purpose.

Speak with an Advisor

If you are planning a section 85 rollover, an estate freeze, or another reorganization that depends on a defensible fair market value, KitsWest Capital welcomes confidential discussions.