A freeze is an exchange, not a sale. Income Tax Act section 86(1) lets a shareholder give up every share of a class and take back new shares whose value is fixed at today’s figure, with proceeds set at the cost of what comes back. New common shares are then issued to whoever is to hold future growth.
Key takeaways
SECTION 01 OF 08
The marginal note is “Exchange of shares by a shareholder in course of reorganization of capital”. Three conditions come first. The disposition must occur “in the course of a reorganization of the capital of a corporation”. What goes is “all the shares of any particular class of the capital stock of the corporation that were owned by the taxpayer at the particular time”, and it must be capital property. What is receivable must include “other shares of the capital stock of the corporation”.
The word doing the work is all: exchange part of a class, keep the rest, and the condition fails. The new shares must be shares of the same corporation, so a move to a holding company runs instead through the section 85 rollover, open only “if the taxpayer and the corporation have jointly elected in prescribed form”. Section 86 needs no election: nothing filed late, nothing chosen.
SECTION 02 OF 08
Paragraph 86(1)(a) prices what is not a new share: the cost of “any property (other than new shares) receivable by the taxpayer for the old shares” is “deemed to be its fair market value at the time of the disposition”. Paragraph (c) then sets the outcome: “proceeds of disposition equal to the cost to the taxpayer of all new shares and other property receivable by the taxpayer for the old shares”. Proceeds are defined by cost, not value, so the accrued gain moves into the new fixed-value shares rather than disappearing.
Paragraph (b) costs those new shares at “the amount, if any, by which” the adjusted cost base of the old shares exceeds the value of any non-share consideration — a figure that cannot go below nil. On parameters of my own choosing rather than data: old shares with an adjusted cost base of $100 and a value of $4,000,000, exchanged for fixed-value preferred shares plus a $250,000 note. The note costs $250,000, the preferred shares nil, proceeds $250,000, gain $249,900 — where dropping the note realises nothing. See also section 84.1 and section 69.
SECTION 03 OF 08
Subsection (2) compares the old shares’ value immediately before the exchange with the non-share consideration plus “the fair market value of the new shares, immediately after the disposition”. Where a shortfall exists and part of it is reasonably regarded “as a benefit that the taxpayer desired to have conferred on a person related to the taxpayer”, that part is added to proceeds and “the taxpayer’s capital loss… shall be deemed to be nil”.
The terms of the frozen shares therefore fix the value coming back. Treadstone Law describes the usual pattern — preferred shares redeemable and retractable at a frozen value, “usually equal to the current fair market value of the business” — in its note on freeze share structure, and the features in common v. preferred shares. Neither the Act nor this page says what a business is worth.
SECTION 04 OF 08
Section 51, marginal note “Convertible property”, covers a narrower exchange: a share acquired from the corporation for another of its shares, or for a convertible bond, debenture or note. Its condition is absolute — it applies only where “no consideration other than the share is received by the taxpayer for the convertible property”. Any boot and section 51 is unavailable. Where it does apply, “the exchange is deemed not to be a disposition of the convertible property”.
The ordering is express and runs both ways. Section 86(3): “Subsections 86(1) and 86(2) do not apply in any case where subsection 85(1) or 85(2) applies.” Section 51(4): “Subsections 51(1) and 51(2) do not apply to any exchange to which subsection 85(1) or 85(2) or section 86 applies.”
SECTION 05 OF 08
Nothing in the Income Tax Act creates a share class. Federally that power is CBCA section 173(1) — “the articles of a corporation may by special resolution be amended to”, among other things, “create new classes of shares”. In Ontario it is OBCA section 168(1), clause (h) of which reaches an amendment to “change the shares of any class or series… into the same or a different number of shares of other classes or series”, authorised under subsection 168(5) by a special resolution: one “passed… by at least two-thirds of the votes cast”. Treadstone Law sets out the filing in articles of amendment.
CBCA section 24(3): “Where a corporation has only one class of shares, the rights of the holders thereof are equal in all respects and include the rights” to vote, to take declared dividends, and to take the remaining property on dissolution. Subsection (4) permits more classes, requiring only that those rights “shall be attached to at least one class of shares but all such rights are not required to be attached to one class”. That is what lets the vote live on one class and the growth on another. OBCA section 22(3) lists two rights rather than three — the vote and the remaining property, with the same at-least-one-class rule in subsection 22(4)(b). Treadstone Law compares the two regimes and lists the voting variants in share classes and votes.
SECTION 06 OF 08
A reclassification does not pass on one company-wide vote. CBCA section 176(1) entitles a class to vote separately on a proposal to “effect an exchange, reclassification or cancellation of all or part of the shares of such class”; OBCA section 170(1)(b) is the Ontario equivalent. Both then use one identical sentence to close the workaround: “Subsection (1) applies whether or not shares of a class or series otherwise carry the right to vote.”
That vote carries a dissent right. CBCA section 190(2) gives it to a holder “entitled to vote under section 176” where the corporation resolves to amend its articles in a manner described there; OBCA section 185(2) is the parallel. Both add, word for word, “The right to dissent described in subsection (2) applies even if there is only one class of shares.” That is squarely the freeze case; the remedy sits in the article on dissent rights, the triggers in Treadstone Law’s list.
SECTION 07 OF 08
Section 74.4(2) engages where an individual has transferred or lent property to a corporation and “one of the main purposes of the transfer or loan may reasonably be considered to be to reduce the income of the individual and to benefit… a person who is a designated person in respect of the individual”. Section 74.5(5) defines that person as one “who is the spouse or common-law partner of the individual”, or “who is under 18 years of age and who” either does not deal at arm’s length with the individual or is the individual’s niece or nephew.
Three conditions must hold throughout. The designated person must clear a 10 per cent test — the specified-shareholder definition catches “not less than 10% of the issued shares of any class of the capital stock of the corporation”. The individual must be resident in Canada. And, deciding most cases, “the corporation was not a small business corporation”: a Canadian-controlled private corporation substantially all of whose assets are “used principally in an active business carried on primarily in Canada”.
Where it engages, “the individual shall be deemed to have received as interest in the year” notional interest on the outstanding amount, less certain credits. That outstanding amount is the value transferred less consideration that is not “excluded consideration” — a term subsection 74.4(1) defines to include a share of the corporation. Freeze shares, being shares, do not reduce it; taxable dividends paid on them do.
SECTION 08 OF 08
Interest runs “at the prescribed rate of interest for such periods”. That rate comes from Income Tax Regulation 4301, paragraph (c) of which covers “every other provision of the Act in which reference is made to a prescribed rate of interest” pointing at the Treasury-bill mean in subparagraph (a)(i), to which (a)(ii) adds four points for overdue tax. For Q4 2026 the CRA states that “The interest rate used to calculate taxable benefits for employees and shareholders from interest free and low-interest loans will be 3%”, against seven per cent on overdue taxes.
Subsection 74.4(4) removes the benefit purpose on three cumulative conditions: that “the only interest that the designated person has in the corporation is a beneficial interest in shares of the corporation held by a trust”; that the trust terms bar that person from taking its income or capital; and that nothing has been received. Section 74.5(4) separately switches the rule off for a spouse “for any period throughout which the individual is living separate and apart from the designated person by reason of a breakdown of their marriage”. Treadstone Law covers it in corporate attribution and transferring shares to children.
Two boundaries. Section 51(1)(e) provides that “for the purposes of sections 74.4 and 74.5, the exchange shall be deemed to be a transfer of the convertible property by the taxpayer to the corporation”; section 86 has no equivalent paragraph. I read the whole section; there is none, and what that silence means is not answered on the face of the Act. Second, this page states what four provisions require. It does not value a business, say whether a freeze is advisable, or address the general anti-avoidance rule. Adjacent questions sit in the 24-month rule and Treadstone Law on multiplying the exemption, an old freeze on a sale and freeze basics.
No. Section 86 applies on its own terms once its conditions are met — no election is filed, unlike section 85(1), which requires a joint election in prescribed form by a deadline, and section 86(3) even switches section 86 off wherever section 85(1) applies instead.
No. Section 86(1) applies only where the taxpayer disposes of all the shares of a particular class that they owned at the time — exchanging part of a class and keeping the rest falls outside the provision entirely, since the word doing the work in the text is all.
It can. Under section 86(2), if that shortfall is reasonably regarded as a benefit the taxpayer desired to confer on a person related to them, the shortfall is added to proceeds, and any capital loss the taxpayer would otherwise have on the exchange is deemed to be nil.
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