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."
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
2014 Ruling 2014-0533601R3 - Spin-off butterfly - subsection 55(2)
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.
2013 Ruling 2013-0491651R3 - Cross-Border Butterfly
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.
2011 Roundtable Q. , 2011-0412191C6
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.
2006 Ruling 2006-017734
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 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:
- 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;
- 100 common shares are issued to Mr. X for $1 each; and
- 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.
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]
Administrative Policy
27 March 2013 Folio S4-F3-C1
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.
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.