When drafting articles of incorporation, one is required to outline the share structure of the corporation. This article seeks to outline some basic requirements, and subsequently the importance of choosing a share structure that is most beneficial for the corporation.
What is a Share? And Who is a Shareholder?
Shares represent an ownership interest in the corporation. A person who owns shares is a shareholder. As a shareholder there are certain rights that person will have with respect to the corporation.
What are the Requirements for Shares?
The articles of incorporation can allow for one or more types of shares. Different types of shares are commonly referred to as ‘classes’ of shares. There is no limit on the number of classes of shares that a corporation can set out in the articles of incorporation. However, if there is more than one class of share the rights, privileges, restrictions and conditions of each class must be outlined in the articles of incorporation. (see OBCA, s.22(4); CBCA,s.24(4)) If there is only one class of shares those shares must give the shareholder at minimum:
- The right to vote;
- The right to receive dividends; and
- The right to receive the remaining property of the corporation after it is dissolved.
If there is more than one class of shares, each of the three listed rights still has to be assigned, but one class does not need to be assigned all three. The corporation can also give each right to more than one class of shares.
For example, you could have Class A, Class B and Class C shares of a corporation. Class A shares have the right to vote, and the right to receive dividends. Class B shares have only the right to receive dividends. Class C shares have the right to receive dividends and the right to receive the remaining property of the corporation after it’s dissolved. As per the example, you can see that no one class of shares must be assigned all three rights. You can decide what rights to attach to each share class in a combination that works for your corporation. *Another important thing to remember is that the corporation can choose a share structure with multiple share classes when incorporating, without having to issue shares in each share class immediately. This helps the corporation set up a share structure that will allows for growth.
How Many Shares Should be Issued?
When drafting the articles of incorporation, one must determine how many shares of each class can be issued. Most corporations do not set any limit on how many shares may be issued per class. The only time a corporation may limit the number of authorized shares in a class is if they wanted to restrict the powers of the directors. By limiting the number of shares, shareholders have the ability to prevent the issuance of more shares. For example, if the directors wanted to issue more shares than allowed in the class, they would need to have the shareholders reach a special resolution to allow them to increase the number of shares in the class. If there is no restriction or limit on how many shares may be issued per class, then the directors do not need shareholders’ approval. For more information, please check out this article: When Forming a Company, How Many Shares Should Be Issued, and at What Price?
How Many Classes of Shares to Include?
Sometimes small business owners or sole proprietors choose to have one class of shares.
Why add another class of shares?
Having multiple classes of shares can be advantageous.
Primarily, this structure enables the corporation to give different dividends to each class. By having separate classes, it is easier to income-split among spouses and/or family members. When considering this structure make sure to consult an accountant and/or lawyer because there are many complicated tax provisions regarding income splitting. However, this model can still be an effective way to sprinkle one’s income if implemented correctly. (see TOSI) An additional benefit to including more than one share class is that a taxpayer can engage in a capital reorganization of the corporation without tax consequences, and without having to amend the articles of incorporation. Including more than one class of shares gives the corporation some flexibility later down the road to change the business structure. (see s. 86.1 rollovers,s.51 share exchanges)
Another possible advantage by including more than one class of shares arises if the corporation has both Canadian resident shareholders and non-resident shareholders. By having more than one class, the corporation is able give capital dividends to resident shareholders, and taxable dividends to non-resident shareholders. Non-resident shareholders are indifferent to the taxable dividends because tax treaties will eliminate the Canadian tax they otherwise would have to pay on the dividend. Likewise, the resident shareholder’s benefit from this structure, because they receive a tax-free return of capital through the capital dividends. We would recommend adding a second class at incorporation for most corporations.
Should a Corporation include Share Restrictions?
The nature of your shares and who holds those shares will determine whether or not your corporation is public or private.
If you want your corporation to remain privately held it is important to place restrictions on the sale of shares. A simple clause in the articles of incorporation can restrict share transfers so that the corporation remains private. This is done by restricting the sale of shares to only approved parties. There are many tax benefits to being designated a Canadian controlled private corporation such as the small business deduction, refundable investment tax credits, and capital gains exemption for qualified small business corporation shares.
How Can Shareholders Protect Their Rights?
Shareholders of each class are entitled to vote separately or as a class, in the event the corporation wishes to amend the articles of incorporation. This protects shareholder’s rights by granting them the power to rally together to preserve the rights of their class. (See OBCA, s.170(1)) When drafting your Articles of Incorporation, you will want to consider the information in the following blogs: