SECTION 86 SHARE EXCHANGE - COMPLEXITY & MISTAKES
To schedule an appointment, contact our law firm at 403-400-4092 or Chris@NeufeldLegal.com
While a section 86 share exchange is an important tax planning strategy, its complexity gives rise to the prospect of serious mistakes, such that an experienced tax lawyer should be engaged to navigate this highly technical tax law procedure. Areas of complexity that can give rise to mistakes in the execution of a section 86 share exchange include:
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Failing to Dispose of All Shares: To qualify for the tax-deferred rollover, the shareholder must dispose of all of the shares of a particular class they own. Leaving even one share behind will void the entire rollover for that class of shares.
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Improperly Valuing Shares: Accurate valuation of both the "old" shares and the "new" shares is critical. The Canada Revenue Agency (CRA) can challenge the valuation, which could lead to an immediate deemed disposition and tax consequences.
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Incorrectly Handling Non-Share Consideration ("Boot"): If the shareholder receives any property other than shares—like cash or a promissory note—in the exchange, this "boot" can trigger a capital gain. This portion of the transaction is not eligible for the tax-deferred rollover.
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Applying Section 86 When Section 85 is Required: Section 86 is specifically for an exchange of shares for shares within the same corporation. If the transaction involves transferring property to a different corporation (even if it's a related one), a Section 85 rollover may be needed instead. Section 86 does not apply if a Section 85 rollover is used.
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Failing to Have a "Reorganization of Capital": Section 86 applies only when the share exchange occurs "in the course of a reorganization of the capital" of the corporation. While this is a broad concept, simply amending the rights of existing shares may not be enough. It may be necessary to formally exchange and cancel the old shares for newly issued ones.
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Ignoring the General Anti-Avoidance Rule (GAAR): The CRA's GAAR can be applied if a transaction is seen as an abuse of the Income Tax Act. A Section 86 exchange must have a legitimate business purpose beyond simply avoiding or deferring tax.
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Improper Documentation: Although a specific election form isn't required for a Section 86 rollover, the transaction must be properly documented in the corporation's and the shareholder's tax returns. Failing to do so can lead to CRA scrutiny and potential penalties.
Given the complexity and potential for severe tax penalties, it is critical that your section 86 share exchange is correctly structured, with the appropriate legal and supporting paperwork, such that it might effectively respond to any scrutiny. With over two decades of legal experience, which includes designing and implementing many section 86 share exchanges and other corporate tax planning strategies, we can put that knowledge and experience to use for the advancement of your business.
Our law firm strives to provide strategic tax-driven legal advice and direction to Calgary businesses looking to optimize their business structures and corporate transactions. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for your business' tax structuring and tax planning initiatives.
