Why should I be concerned about participating and non-participating shares in my company?

Shares in a corporation can be participating or non-participating, among other features. Participating shares are eligible to “participate” in the equity growth of the company and be permitted to receive dividends. Non-participating shares do not benefit from the equity growth of the company. This can potentially impact the valuation of shares.

Discussion:

Private companies commonly issue multiple classes of shares to different members of the family to maximize income splitting potential. Generally, the family members that operate the company will receive voting shares and the non-active family members will receive non-voting shares. This way all family members have access to the profits of the company, but the control of the company is retained by the active shareholders and generally the financial risk to the non-active shareholders is limited to the cost of their shares. Voting is different from participation in profits.

Participating in profits is an attribute of a share and that attribute can be given to voting shares or to non-voting shares. So you can have:

• voting participating
• voting non-participating
• non-voting participating
• non-voting non-participating

If a company has issued different classes of shares with different attributes (i.e. some are voting and some are participating), it can make the classes of shares have different values. Voting shares are generally considered to have value because they can impact the future of the company. But participating shares also can have value because they receive the profits. This mix of voting and participating rights can create confusion for tax purposes. This is important when dealing with the lifetime capital gains exemption (LCGE). If a company was sold resulting in a significant gain, the allocation of the sale price to the various shares could create both opportunities to spread the wealth and thus the tax amongst the shareholders, but as well create contention with the Canada Revenue Agency about which shares actually have the value. This can be particularly important to the seller of the shares if they hope to use tax savings tools like the lifetime capital gains exemption.

Recommendation

If you have questions concerning participating and non-participating shares or voting vs. non-voting, please contact us at Gilmour Group Chartered Professional Accountants for our help on this issue. Good planning when creating share structures at the outset can have a significant impact down the road on taxes payable when a share sale occurs.