Shares are often promised before they are planned. A founder tells his daughter she will have a piece of the business when she finishes university. An owner of a Brampton trucking outfit tells her dispatcher, who has stayed through two bad years, that he has earned 10 per cent. A spouse is added to the share register on an accountant’s suggestion, and nobody writes down why.
These are generous and often sensible decisions, and the mechanics of issuing a share can take an afternoon. The trouble comes from what a share is. A shareholder has legal rights to information, to vote in many cases, to seek court remedies, and to take a portion of the value when the company is sold. Once issued, those rights are hard to take back, particularly if the relationship later breaks down.
This is general information only and not legal or tax advice. Share issuances should be reviewed together by a lawyer and a tax adviser, because a structure that makes sense on the corporate side can create an unwelcome tax result, and vice versa.
Decide What You Are Trying to Give
“Shares” is a broad answer to several different questions. Before choosing a mechanism, separate out what you actually want this person to have:
- A voice in decisions, meaning votes
- A share of annual profits, meaning dividends
- A share of the eventual sale price, meaning growth in value
- A reason to stay for the long term, meaning retention
An adult child joining the business may need all of these eventually, but not today. A valued operations manager may mostly want to share in the upside if the business sells, and may have no wish to take on a director’s role or attend meetings. A family member who will never work in the company may be a poor candidate for voting shares at all.
Ontario corporations can hold different classes of shares with different rights, if the articles allow them. Non-voting growth shares, for instance, can give an employee a stake in the future value without any say over how the company is run. In some cases the answer may not be shares at all: a cash bonus tied to a sale or a phantom plan can deliver much of the same benefit without creating a new shareholder.
Read Your Own Documents First
Check your articles of incorporation before you do anything else. They set out which classes exist, how many can be issued, what rights attach to them, and what restrictions apply. If the class you want does not exist, you will need articles of amendment, which ordinarily call for a special resolution from the shareholders.
Then look at any shareholder agreement. Existing owners may have a consent right, a pre-emptive right to buy their proportion of new shares, or a cap on issuance. A sole owner has no such obstacle, but a company with two equal partners cannot issue a share to one partner’s son without the other partner’s agreement, in practice and usually on paper as well. Issuing to one side changes the balance of control, and if done unfairly, it may attract an oppression claim under section 248 of the Ontario Business Corporations Act (OBCA).
Who actually holds the shares may matter too. Where an existing family holding company or trust sits above the operating company, the right place to issue may be at another level altogether.
Payment Is a Legal Requirement
This is where gifts of shares often go wrong as a matter of corporate law. Under section 23 of the OBCA, a share must not be issued until it is fully paid in money, in property, or in past service. The value received cannot be less than the fair equivalent of what the company would have received had the share been issued for money. A promissory note from the person receiving the shares, or from someone not at arm’s length with them, does not count as property for this purpose.
Two points follow from that. First, future work is not valid consideration under this section. “You get 10 per cent for staying five more years” cannot simply be issued today as if it were paid for by the years ahead. Second, when shares are issued for something other than money, the directors must determine the value, and directors who approve an issuance for inadequate non-cash consideration can be personally liable under section 130 to make up the shortfall, unless they did not know and could not reasonably have known.
Valuation should therefore be handled seriously, particularly in a business with real value. Paying $10 for shares in a company worth millions may raise both corporate and tax concerns. A newly formed or freshly reorganized company may be able to issue founders’ shares for nominal amounts, which is why timing matters. The earlier a stake is given, the lower its cost tends to be.
Securities Law Applies to Private Companies
Many owners are surprised to learn that issuing a share is a “distribution” under Ontario securities law, even when the recipient is their own child. A distribution requires a prospectus unless an exemption applies. Most private companies rely on exemptions under National Instrument 45-106, in particular the private issuer exemption and the separate employee, executive officer, director, and consultant exemption.
The private issuer exemption generally requires that the company’s shares be subject to transfer restrictions, that there be no more than 50 holders (with employees and former employees not counted), and that shares be sold only to listed categories of purchasers. Those categories include directors, officers, employees, founders, control persons, specified relatives of those people, and close friends and business associates, along with some others. Note that not every cousin or in-law automatically fits, and the exemption’s relationship tests have been read narrowly. The categories can have Ontario-specific wording, so they should be checked against the current rule for each proposed recipient.
Employee participation must also be voluntary to fit the employee exemption, meaning the person is not induced to buy by the prospect of keeping the job. Keep a short memo in the file naming the exemption relied upon and why each person qualifies, plus any filing that may be required with the Ontario Securities Commission.
Tax: Family Members
A tax adviser needs to weigh in here, but it helps to know the shape of the issues before the meeting. Three deserve particular attention when family is involved.
Transferring existing shares that have grown in value to a family member other than a spouse is generally treated as a sale at fair market value, whatever price is actually paid, so the giver may face a capital gain with no cash received. Issuing shares from treasury works differently, but a benefit can arise where the shares are issued at less than their worth.
Income splitting rules are restrictive. The tax on split income rules can apply the top rate to dividends paid to family members who are not meaningfully involved in the business, subject to a set of exceptions. Dividends on shares held by a minor child are a common example. Corporate attribution rules can apply too, depending on how the shares were structured.
On the favourable side, a qualified small business corporation share may be eligible for the lifetime capital gains exemption on a later sale, and several family members holding qualifying shares may each have their own exemption. Those benefits depend on strict tests, including holding periods and asset composition, and should never be assumed.
Tax: Employees
Employees have their own regime. When a company agrees to sell or issue shares to an employee, section 7 of the Income Tax Act can treat any discount from fair market value as an employment benefit. Generally, that is the difference between the value when the shares are acquired and the amount paid.
For a Canadian-controlled private corporation, the benefit is deferred until the employee actually disposes of the shares, rather than being taxed at the time of purchase. This is meaningful for someone who has no way to sell shares to fund the tax. A deduction may also be available to reduce the benefit by half, if the employee was dealing at arm’s length with the company and either the shares were priced at no less than fair value when the agreement was made or they are held for at least two years, in addition to other conditions.
Relatives who also work at the company do not usually qualify as arm’s length for those deductions. A manager who becomes a major shareholder may have a different answer. Report the benefit correctly on the T4 when it arises, as the CRA requires.
Stock options are often used instead of immediate shares because they give the employee time, avoid an outright purchase, and allow vesting. Unlike a share, an option can legitimately be tied to future service. Have the plan and grant agreement prepared properly, and the option price set with attention to current value.
Build the Exit Before the Entry
More regret stems from this step being skipped than from any other. Before issuing, decide what happens if:
- The employee quits, or is dismissed with or without cause
- The child leaves the business, or the two of you stop speaking
- The shareholder divorces, dies, or goes bankrupt
- A buyer shows up for the whole company and one holder refuses to sell
A written agreement should handle these scenarios, usually through a call right allowing the company or the remaining owners to buy the shares back on set triggers, a formula for price, payment terms, a drag-along so a minority cannot block a sale, a tag-along if the minority wants to go with the majority, and a restriction on transfers. The broader governance terms belong with your business formation and organization documents. The point here is that a recipient should sign before receiving the certificate, when the goodwill is at its highest.
Any buyback must also respect the OBCA’s solvency tests. A company cannot redeem or buy its own shares if doing so would leave it unable to pay debts as they come due, and directors can be personally liable for approving such a payment. And a court asked to examine a below-value forced buyback might treat it as unfair, so price formulas should make sense on the day they are triggered.
Family Law: The Question Nobody Wants to Raise
Under Ontario’s Family Law Act, the value of property acquired during a marriage generally forms part of a married spouse’s net family property, and that includes growth in shares. A gift from a third party can be excluded in some circumstances, but growth in value and income have their own rules, and exclusions need careful tracing or a domestic contract.
So when you give a married son shares in the business, his spouse may have an indirect claim to their value on separation, without ever holding a share. Parents who want to protect the company can ask for a marriage contract as a condition of the gift, understanding that it is a sensitive subject and that each spouse should get independent legal advice. Shareholder agreements can also let the company repurchase shares upon a marital breakdown.
If you give shares to your own spouse, consider what that does to your family’s position should the marriage end, and also how the attribution rules treat that transfer for tax purposes.
Complete the Paperwork
After the decisions are made, the formal steps are modest, and they should be done at the time, not reconstructed years later:
- A directors’ resolution authorizing the issuance and, where needed, the value determination
- Payment actually received and recorded on the books
- Updated securities register, and a share certificate if your company uses them
- Updated register of individuals with significant control, if the change affects who qualifies
- A signed shareholder agreement or joinder
- A note of the securities exemption relied on
Missing records are a real source of disputes, especially when a business is sold and a buyer’s lawyer asks why a former employee thinks she owns 5 per cent. If you are working through a plan like this for a Brampton company, Sawan Law House LLP can review the proposal with you alongside your accountant.