When the Canada Revenue Agency (CRA) audits a Section 85 rollover, they usually challenge the Fair Market Value (FMV) of the transferred assets. If the CRA disallows the rollover, you could face massive sudden capital gains taxes. Having a valid Price Adjustment Clause and a professional valuation is critical to defending your tax-deferred transfer.
Transferring personal assets, such as real estate or shares, into a Canadian corporation is a common strategy to grow your business. Under Section 85 of the Income Tax Act, this transfer can be done on a tax-deferred basis, meaning you do not pay immediate capital gains tax. However, the Canada Revenue Agency (CRA) frequently audits these transactions. Whether your company operates in Toronto, Vancouver, or Halifax, the federal rules are identical. The CRA meticulously checks if you filled out the Form T2057 correctly and if you honestly valued the property being moved.
A disallowed rollover is financially devastating. It triggers a deemed disposition, meaning the government treats the asset as if you sold it for cash, demanding immediate tax payments. Defending against this requires a deep understanding of corporate tax law and proper legal representation.
Step-by-Step Process for Handling a Section 85 Audit in Canada
Facing a federal tax audit requires patience and extreme attention to detail. Responding incorrectly to an initial CRA inquiry can quickly turn a routine check into a full-scale reassessment of your entire corporate history.
Step 1: Reviewing the CRA Proposal Letter
📩 The process begins when you receive a proposal letter from a CRA auditor. This letter will outline exactly why they believe your Section 85 rollover is invalid. Common reasons include missing the strict filing deadlines for the T2057 election form or a disagreement over the Fair Market Value (FMV) of the transferred business assets.
Step 2: Activating the Price Adjustment Clause (PAC)
Generally, a well-drafted rollover agreement contains a Price Adjustment Clause (PAC). This is your strongest defence. A PAC legally states that if the CRA determines the FMV of the assets is different from what you declared, the purchase price between you and the corporation will automatically adjust to match the CRA’s number. This prevents sudden double-taxation penalties.
Step 3: Justifying the Valuation with Experts
If the CRA auditor ignores your PAC or continues to challenge the value, you must provide independent proof. It is highly recommended to hire a Chartered Business Valuator (CBV) to formally appraise the assets as of the date of the transfer. Sending a professional valuation report often forces the CRA to back down during the audit stage.
Step 4: Filing a Notice of Objection
📝 If the auditor issues a formal Notice of Reassessment disallowing the rollover, you have exactly 90 days to file a Notice of Objection. This moves your case away from the original auditor and into the hands of the CRA Appeals Division. An experienced tax lawyer will draft the legal arguments needed to show the Appeals Officer that the rollover complied with the Income Tax Act.
Step 5: Appealing to the Tax Court of Canada
If the Appeals Division upholds the reassessment, your final option is to file a Notice of Appeal with the Tax Court of Canada. This is a formal litigation process where your law firm will present evidence, expert witnesses, and corporate documents before a federal judge. Most cases, however, are settled with the Department of Justice before a trial actually begins.
Common Section 85 Audit Triggers
| Audit Trigger | CRA Concern | Best Defence Strategy |
|---|---|---|
| Late Filing of Form T2057 | Procedural non-compliance | Paying the late filing penalty immediately |
| Unreasonable Valuation | Hidden capital gains | Using a Price Adjustment Clause (PAC) |
| Improper Share Issuance | No valid consideration given | Reviewing corporate minute books with a lawyer |
How Much Does a Tax Dispute Cost in Canada?
Defending a complex corporate tax audit is a significant investment. As of May 2026, typical costs in CAD include:
- CRA Late Filing Penalty: Generally $100 CAD per month for Form T2057, up to a maximum of $8,000 CAD.
- Chartered Business Valuator (CBV): A formal valuation report usually costs between $3,500 and $10,000 CAD.
- Tax Lawyer Fees (Objection Phase): Drafting a formal Notice of Objection typically ranges from $4,000 to $8,000 CAD.
- Tax Court Litigation: Taking a federal case to trial can easily exceed $25,000 CAD in legal fees.
How Long Does the Process Take?
🕐 Tax disputes are notoriously slow. The initial audit phase can last 6 to 12 months. If you file a Notice of Objection, it currently takes the CRA Appeals Division about 10 to 18 months just to assign an officer to your file. If you are forced to proceed to the Tax Court of Canada, expect the entire litigation process to drag on for 2 to 4 years before a final resolution is reached.
Frequently Asked Questions (FAQ)
Can I file a T2057 election late?
Yes. The CRA allows you to file the rollover election up to three years late, provided you pay the estimated penalty upfront. Filing beyond three years requires special permission from the Minister of National Revenue.
Does a rollover apply to real estate in Canada?
Generally, yes. You can roll an active commercial building into a corporation. However, personal real estate (like your primary residence) or vacant land held strictly for resale often faces stricter scrutiny.
Will I go to jail for a failed rollover?
No. A disallowed Section 85 rollover is almost always a civil tax dispute over valuation or paperwork. Criminal tax evasion charges are extremely rare unless there is deliberate, fraudulent concealment of assets.
Do I need a lawyer for a CRA audit?
While you can self-represent or use an accountant during the early audit phase, retaining a tax law firm is highly recommended if the CRA proposes massive penalties, as lawyers provide solicitor-client privilege.
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