Examples of typical special/preferred share provisions

Examples of typical special/preferred share provisions are as follows:

Non-voting:

• The shares may be non-voting (except in certain situations provided for in the governing legislation). In the "Income splitting" example, above, the shares given to Taxpayer "B" and the children are likely to be non-voting special shares so that Taxpayer "A" does not lose control of XYZ Company Inc.
• In the "Estate freeze" example, above, Taxpayer "A" will likely receive voting special shares so as to retain control of XYZ Company Inc.

Redeemable:

• Redeemable shares are shares that can be reacquired by the corporation from the shareholder at the corporation's option usually at any time (in effect, a "call" provision). In the "Income splitting" example, above, the shares given to Taxpayer "B" and the children are likely to be redeemable special shares so that Taxpayer "A" can eliminate Taxpayer "B" and or any or all of the children as shareholders in the event of a matrimonial or family dispute.
• In the "Income splitting" example, above, the special shares would typically be redeemable at the nominal consideration originally paid by the shareholder to acquire the shares so that the redemption by XYZ Company Inc., in effect, costs the corporation nothing. In the "Estate freeze" example, above, however, the special shares would be redeemable at the value of the shares on the date of the freeze (in the example, $500,000).

Retractable:

• Retractable shares are shares that give the shareholder the right to require the corporation to buy back the shares from the shareholder at the shareholder's option usually at any time (in effect, a "put" provision—the mirror opposite of a redemption provision). In the "Estate freeze example, above, the special shares would be retractable at the value of the shares on the date of the freeze (in the example, $500,000). This gives Taxpayer "A" considerable indirect control over XYZ Company Inc. whether or not the special shares received by Taxpayer "A" on the freeze are voting or non-voting.

Purchase for cancellation:

• Redemption and retraction provisions give the corporation or the shareholder the right to trigger a purchase/sale of the shares at a share price specified in the provision. In certain circumstances, it may be desirable for the corporation to repurchase the shares at a share price that is different from the redemption or the retraction price; for example, the corporation is in financial difficulty and the shares are worth less than the redemption or retraction price.
• The legislation gives the corporation the power (but not the unilateral right) to repurchase its issued shares (see OBCA, s. 30; CBCA, s. 34). Where a corporation purchases its issued shares, the shares must be cancelled or, if the corporation's articles limit the number of authorized shares, the repurchased shares may be restored to the status of authorized but unissued shares (see OBCA, s. 35(6); CBCA, s. 39(6)).
• Strictly speaking, it is not necessary to include a provision in the articles for purchase for cancellation. Nevertheless, some articles do include such a provision either to expand on the statutory provisions or simply to highlight the prospect.

Dividends:

• Dividends may be fixed or variable:
  • A fixed dividend will require or permit the corporation to pay a dividend on the shares typically calculated as a percentage of the amount originally paid for the shares (i.e., the stated capital). Fixed dividends can be "cumulative" or "non-cumulative." Cumulative dividends accrue annually; if the corporation fails to pay the dividend in any year, the dividend becomes a debt due from the corporation to the shareholder. Non-cumulative dividends do not accrue annually and are only payable in the years in which the directors declare such a dividend to be payable. Where a non-cumulative dividend is not paid in any given year, no obligation to pay the dividend is carried forward into subsequent years.
  • A variable dividend allows the corporation to pay a dividend at a time and in an amount that is in the directors' discretion.
  
  
• One of the advantages of using different classes of shares is that a dividend may be declared and paid on one or more classes to the exclusion of the other classes. In the "Income splitting" example, above, and assuming Taxpayer "A" and Taxpayer "B" have two children, Taxpayer "A" could have caused XYZ Company Inc. to issue Class A shares to Taxpayer "B," Class B shares to child #1 and Class C shares to child #2 (with Taxpayer "A" holding the common shares). If subsequently child #1 requires money to fund, for example, university tuition, a dividend can be declared on the Class B shares without having to pay a like dividend to the holders of the other classes of shares.

Liquidation, dissolution or winding-up:

• This provision will determine the extent to which each shareholder will share in the corporation's equity. In the "Income Splitting" example above, if Taxpayer "A" wants to split income but does not want to otherwise share the value of XYZ Company Inc. with Taxpayer "B" and/or the children, then Taxpayer "B" and the children will receive special shares that can be redeemed for nominal consideration and therefore never have a value that exceeds such nominal consideration.
• In the "Capital gains exemption" example, on the other hand, Taxpayer "B" and the children would receive special shares that participate equally with the common shares in the equity of XYZ Company Inc. By way of illustration, if Taxpayer "A" holds one common share, Taxpayer "B" and each of two children each hold one participating special share and the equity value of the corporation is $1,000,000, then the value of each shareholder's share is $250,000. This value would apply on the liquidation, dissolution, winding up or sale of shares to a third-party.
• Finally, in the "Estate freeze" example, Taxpayer "A"'s shares are fixed (frozen) at $500,000. If the equity value of the corporation is $1,000,000, then on the liquidation, dissolution, winding up or sale of the shares to a third-party, Taxpayer "A" will receive $500,000 and, assuming two children, each child would receive $250,000.

Price Adjustment:

• In an estate freeze or similar tax-planned transaction, the determination of the fair market value ("FMV") of the shares on the date of the freeze is critical to the success of the structure. For that reason, a formal valuation of the shares as at the date of the freeze is usually obtained to support the freeze value in the event that CRA contests the value.
• Estate freezes are non-arms' length transactions. Section 69 of the ITA deems non-arms' length transactions to take place at FMV. In the "Estate freeze" example, above, Taxpayer "A"'s share value is frozen at $500,000. If CRA subsequently determines that the FMV of Taxpayer "A"'s shares on the date of the freeze was $600,000, then Taxpayer "A" will have a taxable capital gain of $100,000. To deal with this contingency, it is normal to include a "price adjustment clause" in the share provisions of the "freeze shares" (in the "Estate freeze” example, the special shares received by Taxpayer "A" in exchange for her common shares). The price adjustment clause provides that if the FMV of Taxpayer "A"'s share value is assessed by CRA (or any other taxing authority) to be other than the amount provided for in the freeze transaction, then Taxpayer "A"'s shares are deemed to have an FMV as determined by CRA (as at the date of the freeze).