Section 86

Subsection 86(1) - Exchange of shares by a shareholder in course of reorganization of capital

Cases

Special Risks Holdings Inc. v. The Queen, 86 DTC 6035, [1986] 1 CTC 201 (FCA)

The taxpayer, following a modification in the capital structure of a company ("RMC") exchanged its voting shares of that company for non-voting preferred shares. Pratte J., in responding to an argument that s. 89(5)(a)(ii) could not apply because "the disposition by the appellant of its shares of RMC was not a disposition 'to a person' as required by the subparagraph because RMC could not own its own shares" stated:

"In reality, the surrender by the appellant of its old RMC shares was neither a disposition by the appellant nor a disposition to RMC. However, it is common ground that the substitution of the new RMC shares for the old ones was deemed by section 86 to be a disposition of the old shares in consideration for the new ones. I have no difficulty in deciding that it logically follows that the substitution of the new shares for the old ones must also be deemed to be a disposition to RMC."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 251 - Subsection 251(1) - Paragraph 251(1)(c) relationship enabling one party to dictate terms 144
Tax Topics - Income Tax Act - Section 84 - Subsection 84(9) 160

See Also

Dunstan v. Young, Austen & Young Ltd., [1989] BTC 77 (C.A.)

In finding that an issuance of shares by a company to its existing beneficial shareholder, followed by the application of the subscription proceeds to pay off intercompany indebtedness, was a "reorganization ... of a company's share capital" on ordinary principles, Balcombe L.J. stated:

"an increase of share capital can be a reorganization of that capital ... provided that the new shares are acquired by existing shareholders because they are existing shareholders and in proportion to their existing beneficial holdings."

Administrative Policy

2017 Ruling 2016-0679281R3 - subsections 84(4.1) and 86(1)

pubco spin-off of a U.S. business using s. 86
Preliminary reorganization

An arrangement agreement is entered into between Parent (a listed Canadian public corporation) and its new subsidiary Newco (governed by the same Business Corporations Act as Parent) and a preliminary reorganization is competed, including a transfer by “Second Tier US Subsidiary” of two LLCs (the “Specified Subsidiaries”) carrying on active businesses to US Holdco and the transfer by Parent of its shares of US Holdco to Newco for Newco shares on a non-rollover basis (given an expectation that the ACB of the transferred shares should equal their aggregate FMV at that time).

S. 86 reorg

Parent will effect a reorganization of its capital. The notice of articles and articles of Parent will be amended:

(i) To change the Common Shares into Class A Common which, in contrast to the Common Shares, will have more than one vote per share;

(ii) To create a new class of common shares of Parent (the “New Common Shares”), which will have the same terms and attributes as the Common Shares immediately prior to the change in (i).

Each issued and outstanding Class A Common Share will then be exchanged for one New Common Share and a specified fraction of a Newco Share (the “Exchange”), with no s. 85 election being made.

The capital respecting the newly-issued New Common Shares equals the aggregate PUC of the Class A Common Shares minus the aggregate FMV, at the time of the Exchange, of the Newco Shares so distributed; and the aggregate FMV at that time of the Newco Shares will not exceed the aggregate PUC respecting the Class A Common Shares.

Rulings

Re the change of the common shares into Class A Common Shares not being a disposition and re the application of s. 86 and non-application of ss. 84(2), (3) and (4.1) to Exchange.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Disposition change of common shares into multiple-voting common shares not a disposition 158

2016 Ruling 2016-0635101R3 - 55(3)(a) Spin-Off to Use Parent Losses

s. 86(1) applied where “dirty” s. 85 exchange mechanic used, but no s. 85 election made

As a preliminary step in a s. 55(3)(a) spin-off transaction, a preliminary s. 86 reorg was effected through an exchange of the “old” common shares of Subco for newly created common shares (having more votes per shares) and preferred shares also newly created by articles of amendment (having a distinguishing dividend feature which, in fact, was not utilized before the shares were redeemed) pursuant to a share exchange agreement - rather than by virtue of articles of amendment changing the old shares into the new shares. CRA ruled that s. 86(1) would apply.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 13 - Subsection 13(21.1) - Paragraph 13(21.1)(a) where land transferred under s. 85(1) along with terminal loss building, elect high with a view to s. 13(21.1)(a) applying to reduce the land proceeds to ACB 177
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3) - Paragraph 55(3)(a) 55(3)(a) spin-off of property already subject to sale agreement to parent before closing date 548
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1) - Paragraph 85(1)(a) elected amount deterines proceeds before s. 13(21.1)(a) grind 197

2016 Ruling 2015-0623731R3 - Subsections 55(2) and (2.1)

stated capital of old shares required to be prorated amongst new classes based on relative FMV

As part of a s. 55(3)(a) spin-off transaction, Sub2 and its Parent undertake a s. 86 reorganization of Sub 2’s capital so that, following articles of amendment, Parent will exchange all of the issued and outstanding shares of Sub2 for Sub2 New Common Shares and (non-voting redeemable retractable) Sub2 Preferred Shares. A paragraph was added to the ruling letter stating:

[T]he aggregate [stated] Capital of the newly issued Sub2 New Common Shares and Sub2 Preferred Shares for purposes of Act 2 will be equal to the PUC of the Exchanged Sub2 Shares, immediately before the exchange, and … such Capital will be allocated to the newly issued Sub2 New Common Shares, as a class, and to the newly issued Sub2 Preferred Shares, as a class, proportionately based on each classes respective FMV.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3) - Paragraph 55(3)(a) requirement to pro-rate PUC 530
Tax Topics - Income Tax Act - Section 80 - Subsection 80(1) - Forgiven Amount policy on set-off of unequal redemption notes does not extend beyond a butterfly reorg 389

2015 Ruling 2014-0558831R3 - No-type of property spin-off butterfly

new common shares with same attributes as old subject to rights of new special shares/pro rata PUC

DC is a public corporation with two classes of common shares (namely, multiple and subordinate voting shares). Preliminarily to a butterfly spin-off by DC to Spinco, there is a s. 86 exchange respecting both the multiple voting and subordinate voting shares, in each case, for shares of two "new" classes, ie., "new" common shares and redeemable special shares. Immediately before the exchange, both Class will be redesignated pursuant to Articles of Amendment and have their number of votes per share increased (presumably , proportionately). Then, on each of the two s. 86 exchanges, the stated capital of each old common share is to be allocated to that of the two new replacement shares based on their relative FMV. The new common shares issued on each of the two exchanges have identical attributes to the old ones (before their votes per share were momentarily increased), except for their share provisions referring to the prior rights of the special shares (mainly, to receipt of any redemption amount).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution prior drop-down of assets to Newco/split of DC manager's business/CEC proration/replacement option issuance as boot 1106
Tax Topics - Income Tax Act - Section 7 - Subsection 7(1.4) replacement stock options issued by Spinco treated as boot 108
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1) - Paragraph 85(1)(d) proration of CEC preliminary to butterfly 154
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Disposition splitting of fee for management of 2 divisions not a disposition of contract 139

2014 Ruling 2014-0533601R3 - Spin-off butterfly - subsection 55(2)

new common shares distinct on basis of right to interim financials

A spin-off butterfly reorganization by DC (a Canadian controlled private corporation) commenced with what was ruled to be a s. 86 reorganization under which the DC shareholders exchanged their old common and preferred shares for special "butterfly" shares and new common shares. The new common shares' attributes were accepted as being different from those of the old shares on the basis of a more restricted right to receive stock dividends and on the basis of a right of the holders to receive quarterly financial statements.

See summary under s. 55(1) – distribution.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 186 - Subsection 186(1) matching of PUC of cross-shareholdings to match Part IV tax 144
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution spin-off by CCPC under Plan of Arrangement of two businesses/matching of PUC of cross-shareholdings to match Part IV tax/leased property as business property 916
Tax Topics - Income Tax Act - Section 84 - Subsection 84(1) stated capital distribution effected by set-off 69

2013 Ruling 2013-0491651R3 - Cross-Border Butterfly

exchange for substantively identical common shares

Preliminarily to a split-up butterfly of DC which, in turn will precede a spin-off by Foreign PubCo (DC's non-resident indirect public company parent), the common shares of DC will be changed by articles of amendment into a shares of a new class of common shares (the "DC New Common Shares") having one vote per share and shares of a new class of non-voting redeemable retractable non-cumulative special shares (the "DC Special Shares"), with the cumulative stated capital of the issued DC New Common Shares and DC Special Shares not exceeding that of the old common shares.

CRA did not rule that this reorganization would qualify under s. 86.

See detailed summary under s. 55(1) - distribution.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 55 - Subsection 55(1) - Distribution cross-border b/f with 3-party exchange, cash-out of ineligible shareholders, proportionate allocation of foreign spinco debt, pension liability classification, prelim non-series dividend 945
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3.1) - Paragraph 55(3.1)(a) preliminary LP acquisition, cross-border debt repayments and dividend: not part of series 212
Tax Topics - Income Tax Act - Section 55 - Subsection 55(3.1) - Paragraph 55(3.1)(b) - Subparagraph 55(3.1)(b)(i) cross-border b/f with 3-party exchange, pro rata application of upper tier debt, cash-out of ineligible shareholders 457

7 October 2011 Roundtable, 2011-0412191C6 - Sec. 86 - Reorganisation of the Capital of a Corp.

conversion without change to authorized capital

given that a conversion from one class or series into another class or series under s. 91 of the Quebec Business Corporations Act generally will not entail any change to the corporation's authorized capital, s. 51 rather than 86 usually will apply.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 51 - Subsection 51(1) s. 51, not s. 86, applies to conversion 39

2010 Ruling 2010-0373801R3 - Conversion from a BV to a DC

exchange of shares in Netherlands BV for membership interests in Dutch coop qualified under s. 86
Proposed transactions

BV, which is a private limited liability company under Dutch law, will convert into a Dutch cooperative ("DC") pursuant to the Dutch Civil Code. By virtue of the execution of the notarial deed effecting the conversion before a notary, DC will be regarded as a legal entity under the Dutch Civil Code that continues to exist separate and apart from its shareholders. On the conversion of BV into DC, the issued share capital of BV will be cancelled and its shareholders (Holdco and Newco) will automatically become members of DC holding membership interests proportionate to their respective shareholdings in BV immediately before such conversion.

Ruling

The cancellation of the shares in the capital of BV on the conversion in exchange for the issuance of the membership interests in DC will occur on a tax-deferred basis under s. 86(1).

2006 Ruling 2006-0177342R3 - Creation of an income trust

With a view to implementing a butterfly reorganization, the common shares of BCo are exchanged for newly created common shares of CCo (having the same attributes as the exchanged common shares) and newly created preferred shares.

S.86 ruling given but with comment that "GAAR might apply if the purpose of such reorganization is to take advantage of the exception in subsection 84(4.1)".

10 April 2001 External T.I. 2001-007440

A simplified example.

28 Aug. 89 T.I. (Jan. 90 Access Letter, ¶1080)

The fact that the exchange shares were authorized before the exchange was contemplated would make little difference as to whether the shares disposed of on the exchange would be disposed of in the course of a reorganization, unless other factors dictated otherwise.

ATR-22R (14 April 89)

Favourable rulings are given where:

  1. Holdco "exchanges" 100% of the issued common shares of Opco for redeemable retractable non-voting special shares with a 7% non-cumulative dividend, special class voting rights and the standard asset depletion protections;
  2. 100 common shares are issued to Mr. X for $1 each; and
  3. Mr. X gifts the common shares to his 40-year old son.

87 C.R. - Q.67

The automatic conversion of an old share to a new share of another class would not necessarily be a reorganization for purposes of section 86.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 51 - Subsection 51(1) automatic conversion 9

Articles

Paul Tamaki, "Book4Golf: Convertible Share Financing", Corporate Finance, Vol VII, No. 2, 2000, p. 731

Discussion of utilization of s. 86 reorganization in order to receive boot (warrants) on a tax-free basis.

Ewens, "Reorganizations of Capital: Section 86", 1995 Canadian Tax Journal, Vol. 43, No. 3, p. 783.

Smith, "Corporate Restructuring Issues: Public Corporations", 1990 Corporate Management Tax Conference Report, pp. 6:28-6:32.

Subsection 86(2) - Idem [Exchange of shares by a shareholder in course of reorganization of capital]

See Also

Mady v. The Queen, 2017 TCC 112

family members did not acquire beneficial interest in new shares until after completion of s. 86 reorg

The taxpayer, who owned all the shares of his dental corporation (“MDPC”), agreed to sell all the MDPC shares to third-party purchaser and its affiliate (collectively, “DCC”) for $4.5 million. Immediately before the closing of the sale to MDPC, the taxpayer exchanged all his commons shares of MDPC under s. 86 for preferred shares with a redemption value of $2 million and for new common shares of MDPC, and then immediately sold 85% of those common shares equally to his wife and two children for nominal consideration. Those three family members then immediately sold those common shares to DCC for cash proceeds of $2.2 million (or $0.74 million each). The Minister reassessed the taxpayer under s. 86(2) on the basis that the shares received by the taxpayer on the reorganization (being the preferred shares and 15% of the new common shares) had a value lower than the $4.5 million value of the old common shares.

Hogan J found that s 86(2) did not apply, stating (at paras 126, 127 and 130):

For subsection 86(2) to have applied, the Appellant’s wife and children would have to have been shareholders of MDPC prior to the share reorganization or have become shareholders of MDPC as a result of the share reorganization.

[T]here is no evidence that shows that the Appellant conveyed a beneficial interest in the aforementioned shares prior to the completion of the purchase and sale arrangement with his family member

… [B]ecause the Appellant’s wife and daughters did not have an interest in the 85 Class B, C and D common shares prior to the time they purchased them from the Appellant later on the same day, no benefit was conferred on them directly or indirectly as a consequence of the completion of the capital reorganization of MDPC.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 74.5 - Subsection 74.5(11) transfer from wife to higher-income husband was infused with his income-splitting purpose (as well as regulatory breach if she didn’t transfer) 355
Tax Topics - General Concepts - Ownership wife and children did not acquire beneficial interest in shares the taxpayer was to transfer to them, under tax plan, until the share transfer occurred 253
Tax Topics - General Concepts - Fair Market Value - Shares arm’s length sales price established FMV for closing-date internal transfer of same shares 470
Tax Topics - Income Tax Act - Section 69 - Subsection 69(1) - Paragraph 69(1)(b) - Subparagraph 69(1)(b)(i) contemporaneous arm’s length sale price established that shares previously transferred at undervalue 468
Tax Topics - Income Tax Act - Section 163 - Subsection 163(2) was not responsible under s. 163(2) for the unbeknownst sharp practice of his tax advisor 658
Tax Topics - General Concepts - Price Adjustment Clause no jurisdiction to comment on application of price adjustment clause where the affected taxpayers are not appellants 223

Administrative Policy

S4-F3-C1 - Price Adjustment Clauses

CRA will consider a price adjustment clause to represent pricing at fair market value if:

  • the agreement reflects a bona fide intention of the parties to transfer property at FMV;
  • the purported FMV is determined by method that is fair and reasonable in the circumstances (which does not necessarily entail using CRA's preferred method, nor engaging a valuation expert);
  • the parties agree that a CRA or Court valuation, if any, will supersede the price otherwise determined; and
  • the excess or shortfall is actually refunded or paid, or legal liability therefor is adjusted (para. 1.5).

Price adjustment clauses involving shares may use a number of adjustment mechanisms. CRA non-exhaustively mentions changes in redemption value, the issuance of a note or change in the principle amount of a note, or a change in the number of shares issued - although CRA recommends against using the latter because of inherent legal and technical difficulties (para. 1.6).

1996 Corporate Management Tax Conference Round Table, Q. 13 (C.T.O. "Benefit of Conversion")

Although s. 86(2) does not contain an exclusion for wholly-owned corporations, ordinarily RC would not consider that it is reasonable to regard any difference between the fair market value of preferred shares of a wholly-owned subsidiary and the fair market value of common shares of the subsidiary for which they are exchanged as a benefit that the parent corporation desired to confer on the subsidiary.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 51 - Subsection 51(2) 64

24 March 1993 T.I. (Tax Window, No. 30, p. 1, ¶2490)

Re potential application of s. 86(2) where, following a decline in the fair market value of Opco, the holder of redeemable preferred shares exchanges those preferred shares for new preferred shares having a lower redemption amount and for an option, while his son continues to hold the common shares.

1993 A.P.F.F. Round Table Q. 6

S.86(2) normally should not apply to an estate refreeze in which preferred shares having a redemption value of $2 million and a fair market value of $1.5 million are exchanged for shares of a new class that are redeemable for $1.5 million.

Subsection 86(3) - Application

Administrative Policy

1995 Tax Executives Institute Round Table Q. 21 (C.T.O. Fax Service Doc. No. 9510750)

Where all the outstanding common shares of Opco are held by Publico, and following the amendment of the articles of Opco, Publico exchanges half of the outstanding common shares of Opco for redeemable retractable preferred shares and one common share of Opco, then, depending on the circumstances, the Department will consider the application of s. 245(2) where a s. 85(1) election was filed for the purpose of creating classes of shares having adjusted cost bases that are not in proportion to their fair market values.