Analyzing Section 86 of the Canadian Income Tax Act: Implications for Corporate Reorganizations

In the realm of corporate taxation, Section 86 of the Canadian Income Tax Act stands as a pivotal regulation, particularly concerning the tax implications of specific corporate reorganizations. This section addresses scenarios where a shareholder exchanges shares from one corporation for those of another, or when a corporation divests its assets to another entity in return for share ownership.

Crucially, Section 86 articulates the provisions for tax deferral on the disposition of initial shares or assets. It permits a ‘roll-over’ mechanism, whereby the tax base of the original shares or assets is transferred to the new acquisitions. Consequently, this defers tax obligations to the point of subsequent disposition of these new shares or assets.

The legislative intent behind Section 86 is to streamline corporate transactions such as mergers, acquisitions, and restructurings. By offering a tax-efficient method for the exchange of shares and assets, the section mitigates immediate tax liabilities for both corporations and shareholders.

More specifically, Section 86 facilitates intra-corporate share exchanges. It permits corporations to substitute an entire class of shares with a different class, exempting both the entity and its shareholders from immediate tax burdens.

For the application of Section 86, certain prerequisites must be met. Primarily, the exchange should be part of a comprehensive reorganization of the corporation’s capital structure. In this process, taxpayers are obligated to relinquish all shares of a particular class (‘old shares’) in exchange for different shares from the same corporation (‘new shares’), without triggering a deemed disposition.

To qualify for Section 86, the following criteria must be satisfied:

• The shares involved must be classified as capital property.
• Complete divestiture of all shares of a specific class owned by the taxpayer is required.
• The taxpayer must receive shares of the corporation in exchange, although additional non-share consideration is permissible.
• Section 86 is inapplicable if subsection 85(1) or (2) applies.
• Notably, no formal election under Section 86 is necessary.

Furthermore, the Adjusted Cost Base (ACB) and Paid-Up Capital (PUC) of the exchanged shares will be transferred to the new shares. For instance, exchanging 100 Class A common voting shares with an ACB and PUC of $100 and a fair market value of $100,000 for 1,000 Class C preferred non-voting shares, each with a redemption value of $100, results in the ACB and PUC of $100 being attributed to the Class C shares.

This provision ensures neutrality in tax implications, as the exchange does not constitute an actual economic transfer.

For entities contemplating a reorganization, professional guidance is indispensable. At Shajani CPA, we offer specialized services in tax planning and corporate restructuring, ensuring compliance and optimization under Section 86 of the Canadian Income Tax Act.

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. ©2024 Shajani CPA.

Shajani CPA is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning services.