A Section 86 reorganization under the Canadian Income Tax Act allows business owners to exchange their existing corporate shares for a new class of shares on a tax-deferred basis, effectively avoiding immediate capital gains taxes. This is the primary legal mechanism used for estate freezing and succession planning, with corporate lawyer fees generally starting around $3,500 CAD.
As a successful Canadian business owner, you may eventually need to restructure your company to bring in new partners, pass the business down to your children, or lock in the current value of your hard work. However, simply trading your valuable common shares for new shares would normally trigger a massive capital gains tax bill from the Canada Revenue Agency (CRA). Fortunately, Section 86 of the Income Tax Act provides a legal safe harbour.
A Section 86 share exchange is a “rollover” provision that allows you to reorganize your company’s share capital entirely tax-free. This strategy is incredibly popular among family businesses in Calgary, Montreal, and Ottawa. Implementing this properly requires a team of legal and financial experts. If you need to restructure your corporation, you can easily find a seasoned corporate tax lawyer or accountant in our Canadian directory to guide your reorganization. 📍
Step-by-Step Process in Canada
Section 86 is a federal tax provision, but executing it requires amending your provincial or federal corporate charter. Whether your company is registered under the Canada Business Corporations Act (CBCA) or the Business Corporations Act of your specific province, the sequence of legal events is critical.
Step 1: Consulting with a Tax Professional
Never attempt a corporate reorganization without professional advice. You must sit down with a corporate tax lawyer or a Chartered Professional Accountant (CPA). They will review your current share structure and confirm that a Section 86 exchange is the most tax-efficient method for your specific goals (such as an estate freeze). 👤
Step 2: Valuing the Corporation
Before any shares can be exchanged, you must determine exactly what your company is worth today. You will generally hire a Chartered Business Valuator (CBV) to assess the fair market value of your corporation. This is essential because the new shares you receive must be legally equivalent in value to the old shares you surrender; otherwise, the CRA may penalize you.
Step 3: Filing Articles of Amendment
Your lawyer will draft “Articles of Amendment” and file them with your provincial corporate registry (or Corporations Canada). This legal document formally changes the company’s constitution, creating the new classes of shares you need. For an estate freeze, you will typically create new fixed-value “preference shares” to exchange for your old growing “common shares.” 📝
Step 4: Executing the Share Exchange
Once the government approves the amendment, your lawyer will draft the internal corporate resolutions. You will physically (or digitally) surrender your old common share certificates back to the corporation. The corporation will cancel them and issue you the newly created preference shares.
Step 5: Updating the Minute Book
Finally, your corporate minute book must be perfectly updated. The lawyer will update the central securities register, ensuring the paper trail clearly shows that the exchange happened in the course of a reorganization of the corporation’s share capital, fully satisfying the requirements of Section 86. 📁
How Much Does it Cost in Canada?
A Section 86 reorganization is highly technical and requires a budget for premium professional services, though it saves you hundreds of thousands in taxes. 💰
- Corporate Lawyer Fees: Drafting the Articles of Amendment, director resolutions, and updating the minute book typically costs between $3,500 and $8,000 CAD, depending on the complexity.
- Valuation Fees: A formal valuation report by a CBV generally ranges from $3,000 to $10,000 CAD.
- Government Filing Fees: Provincial or federal registries charge a minor fee (usually $150 to $250 CAD) to file the Articles of Amendment.
| Tax Requirement | Rule under Section 86 |
|---|---|
| Capital Property | The old shares must be held as capital property, not as inventory. |
| Complete Reorganization | You must dispose of all shares of that specific class that you own. |
| Consideration Received | You must receive new shares of the same corporation in return. |
How Long Does the Process Take?
Executing a Section 86 rollover is a multi-step process. Valuing the business usually takes 4 to 6 weeks. Filing the corporate amendments and drafting the legal resolutions takes another 2 to 4 weeks. Overall, you should expect the entire reorganization to take 2 to 3 months to complete securely. ⏱
Frequently Asked Questions (FAQ)
Do I have to file a special tax election form with the CRA?
No. Unlike a Section 85 rollover (which requires filing Form T2057), a Section 86 share exchange happens automatically by operation of law if all the conditions are met. You simply report the reorganization on your annual corporate and personal tax returns.
Can I receive cash along with my new shares?
Yes, but you must be incredibly careful. If you receive cash or promissory notes (referred to as “boot”) in addition to the new shares, and the value of that cash exceeds the Paid-Up Capital (PUC) or Adjusted Cost Base (ACB) of your old shares, you will trigger an immediate taxable capital gain.
Can I use Section 86 to transfer shares to a holding company?
No. Section 86 only applies to an internal reorganization where you exchange shares for new shares within the exact same corporation. If you are moving shares to a different holding company, you must use a Section 85 rollover instead.
Is a Section 86 exchange the same thing as an Estate Freeze?
Section 86 is the specific legal mechanism used to accomplish an estate freeze. By exchanging your old common shares for fixed-value preference shares, you “freeze” your value and allow the future growth to accrue to new common shares owned by your children or a family trust.
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