A Section 86 reorganization allows Ontario business owners to exchange their common shares for fixed-value preferred shares on a tax-deferred basis. This strategy locks in corporate value without triggering immediate capital gains taxes to the Canada Revenue Agency (CRA).
As your Ontario corporation grows, the original share structure you set up during incorporation may no longer serve your financial goals. Perhaps you founded a successful manufacturing firm in Kitchener or a flourishing tech agency in Ottawa, and now you want to bring in a new partner, implement a family succession plan, or lock in your retirement equity.
Under the Income Tax Act, a Section 86 capital reorganization is a highly effective tool utilized by corporate lawyers and accountants. It allows a shareholder to surrender all their existing shares in a specific class and receive new shares in return, effectively “rolling over” the equity without treating it as a taxable sale. This guide details how to navigate a Section 86 share exchange safely and legally in Ontario. 📍
Step-by-Step Process for a Section 86 Reorganization
Executing a Section 86 rollover is a delicate balance between corporate law under the Ontario Business Corporations Act (OBCA) and strict federal tax regulations. A minor misstep can lead to an unexpected and massive tax bill from the CRA.
Step 1: Obtain a Fair Market Valuation
Before any shares can be exchanged, you must know exactly what the corporation is worth today. You cannot simply guess the value of your business. 💵
You will need to hire a Chartered Professional Accountant (CPA) or a certified business valuator to determine the precise Fair Market Value (FMV) of the company. The new preferred shares you receive during the exchange must have a redemption value exactly equal to the FMV of the common shares you are giving up.
Step 2: File Articles of Amendment
If your current Ontario corporation only has one standard class of common shares, you will need to create a new class of shares for the exchange. Your corporate lawyer will draft Articles of Amendment to authorize the creation of fixed-value, non-participating preferred shares.
These preferred shares typically carry voting rights to maintain control but do not participate in the future growth of the company. The Articles of Amendment are then filed with the Ontario Business Registry.
Step 3: Execute the Share Exchange Agreement
Once the new shares are authorized, the shareholder and the corporation enter into a formal Share Exchange Agreement. This legal contract documents the surrender of the old common shares back to the company treasury in exchange for the newly minted preferred shares. ✍
The agreement must contain a “price adjustment clause.” This is a critical legal safety net. If the CRA ever audits the reorganization and disagrees with your initial valuation, the price adjustment clause automatically corrects the value of the preferred shares to avoid devastating tax penalties.
Step 4: Update the Corporate Minute Book
Finally, the administrative legal work must be finalized. Your corporate lawyer will cancel the old share certificates, issue the new preferred share certificates, and update the shareholder ledgers and registers within your corporate minute book.
Unlike a Section 85 rollover, a Section 86 reorganization happens automatically if all criteria are met, meaning no special election forms generally need to be filed with the CRA. However, the transaction must be carefully reported on your corporate and personal tax returns for the year.
How Much Does it Cost in Ontario?
A Section 86 reorganization requires a coordinated effort between a corporate lawyer and a tax accountant. While it requires an upfront investment, the tax savings are often substantial. 💰
| Service Needed | Estimated Cost (CAD) |
|---|---|
| Independent Business Valuation | $3,000 to $10,000+ (varies by company size and complexity). |
| Articles of Amendment Filing Fee | $150 (mandatory provincial fee via the Ontario Business Registry). |
| Corporate Lawyer Legal Fees | $2,500 to $6,000 (drafting amendments, resolutions, and the share exchange agreement). |
| Tax Accounting & Planning | $2,000 to $5,000 (structuring the rollover properly with the CRA in mind). |
How Long Does the Process Take?
Proper tax planning should never be rushed. Attempting to complete a capital reorganization at the last minute before the fiscal year-end can result in costly errors. ⌛
The longest part of the process is usually obtaining the independent business valuation, which can take 3 to 6 weeks. Once the valuation is finalized, an experienced Ontario corporate lawyer can typically draft the Share Exchange Agreement, file the Articles of Amendment, and reorganize the minute book in 2 to 4 weeks.
Frequently Asked Questions (FAQ)
What is the difference between Section 85 and Section 86?
Section 85 is typically used when you are transferring personal assets (like real estate or equipment) into a corporation in exchange for shares. Section 86 is specifically used for reorganizing the existing share capital of a single corporation, allowing a shareholder to swap one class of shares for another.
Will I lose control of my company after the reorganization?
No, you do not have to lose control. Most corporate lawyers will structure the new preferred shares to carry multiple voting rights. This allows the founder to freeze their equity value while still maintaining 100% voting control over the corporation’s daily operations and board of directors.
Do I have to file a specific form with the CRA for Section 86?
Unlike a Section 85 rollover, which requires filing Form T2057 with the CRA, a Section 86 rollover occurs automatically under the Income Tax Act provided all legal conditions are met. However, the disposition of the old shares must still be declared on your annual tax return.
Why exchange common shares for preferred shares?
Common shares fluctuate in value based on the company’s growth. Preferred shares can be assigned a fixed redemption value. By swapping common for preferred, you “freeze” your personal tax liability at today’s value, allowing new shareholders (like your children) to subscribe to new common shares and capture all future growth.
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