1. Section 86

2. Typical scenarios
Shareholder of a company wants to bring in additional shareholders for:
Income splitting
Splitting the future growth of the company
Reorganize the voting rights of a company (controlling who gets to control the company)

3. What is it?
With section 86, shareholder can surrender all of the shares (in one class) that he/she owns in the company and in return, get back another class(es) of shares without triggering tax
Example:
Surrender all Common shares Bob owns and take back preferred shares
Surrender all Class A common shares Bob owns and take back some preferred shares and Class B Common shares
Can take back boot (non-share consideration) but typically not as it will likely trigger tax

4. What is it?
With section 86, shareholder can surrender all of the shares (in one class) that he/she owns in the company and in return, get back another class(es) of shares
Example:
Surrender all Common shares Bob owns and take back preferred shares
Surrender all Class A common shares Bob owns and take back some preferred shares and Class B Common shares

5. Quick example
Bob is the sole owner of Bob Jones Inc. (owns 100 Common shares)
He wants to add his adult child (James) and his spouse (Lisa) as a shareholder. He wants James to be entitled to 60% of future growth, wants 30% of future growth to go to Lisa, and the rest to him.
Company is now valued at $1M

6. Quick example Bob will use section 86 to accomplish the following:
Bob will surrender his 100 C/S and take back, 1M preferred shares with stated value of $1/share
Company will issue 60 C/S to James, 30 C/S to Lisa, and 10 C/S to Bob
This step is achievable since the company had $1M in value but with step 1, it acquired $1M of retractable P/S which is kind of like debt. So the company has value of $1M and a debt of $1M which means company is worthless. So it can issue new common shares at nominal amount -> VERY IMPORTANT

7. Example (Before)
Bob
100 C/S
Bob Jones Inc.

8. Example (After) Bob James Lisa Bob Jones Inc. 60 C/S 1,000,000 P/S

9. Requirements The following are the requirements:
The exchanged shares must be capital property.
The exchanged shares must be all of the shares of a particular class of the corporation's capital stock that the taxpayer owned at the particular time.
The exchange of shares must occur "in the course of a reorganization of capital" of the corporation*.
The consideration received must include other shares of the corporation.
Section 85 does not apply to the transaction, as long as an election is not filed.

10. Requirements
*The Act does not define the phrase "reorganization of capital" and the Canada Revenue Agency (CRA) has not issued any policy pronouncements on its definition. However, the general belief is that an amendment to a corporation's articles of incorporation constitutes a reorganization of capital sufficient to meet section 86 requirements.
So basically, file an article of amendment even if the amendment is for something trivial. We typically just add more share classes just to file articles of amendment

11. Corporate Attribution rule
Beware of the corporate attribution rule
Typically, the transferor need to take dividend equal to 1% of face value of shares they take back

12. Case study – Grate Manu Inc.
Jordan is 100% owner of Grate Manu Inc.
He wants to retire and give the business to his daughter – Lindsey
Jordan doesn’t want to participate in the future growth of the company. However, he would still like to control the company for two more years
Company is currently worth $10M

13. Solutions? Suggested solution:
Jordan uses s86 to surrender his common shares and take back 10M Class E P/S at $1/share. This share is non-voting
Immediately after the rollover, Jordan subscribes for 101 Class F P/S. This share does not participate in future growth but is voting
Lindsey after s86 subscribes for 100 Common shares
After 2 years, Jordan can have the company redeem his entire Class F P/S for $101

14. Example (Before)
Jordan
100 C/S
Grate Manu Inc.

15. Example (After) Jordan Lindsey 100 C/S 10,000,000 P/S Class E
101 P/S Class F
Grate Manu Inc.

16. Taking a step further
Now Jordan has this $10M preferred shares. What to do with this?
Perhaps he can roll this into a Hold Co using s85 to trigger capital gain if it qualifies for LCGE?
He can have the company redeem his preferred shares over many years – this is considered deemed dividend (part of retirement tax planning?). This is called thawing
In any case, he needs to take out dividend equal to 1% of $10M annually to avoid corporate attribution rule

17. Case study – Event Catering Inc.
Larry owns 65% of Event Catering Inc. (65 C/S)
Sally owns 35% of Event Catering Inc. (35 C/S)
Company is worth $1M
They both want to set up a Hold Co respectively and want the future growth to go to their Hold Co.
Larry and Sally agreed that although the ownership will remain at 65/35, they want to voting rights to be even at 50/50
What to do?

18. Case study – Event Catering Inc.
Larry and Sally can use s86 to surrender their common shares and take back Class E preferred shares at $1/share
Their Hold Co can subscribe for new common shares at nominal amount since value of company at this point is zero
Sally can also subscribe for 30 Class F preferred shares at $0.001/share with voting rights

19. Example (Before)
Larry
Sally
35C/S
65 C/S
Event Catering Inc.

20. Example (Before) Larry Hold Co. Sally Hold Co. Larry Sally 35 C/S
350,000 P/S Class E
650,000 P/S Class E
30 P/S Class F - Voting
Event Catering Inc.
Question: Can Larry do this reorg by himself if Sally doesn’t want to transfer ownership to her Hold Co?