Discretionary shares

What is it?

Since the Supreme Court of Canada recognised the legality of discretionary dividend shares, they have been widely used by lawyers and tax practitioners.

Discretionary shares are unique in that they allow a dividend to be declared on different classes of shares at the sole discretion of the Board of Directors, regardless of the number or percentage of shares in each.

These shares may be participating, i.e. entitled to the remainder in the event of dissolution and to dividends, or non-participating. At the time ofincorporation, if such shares are required, the authorised share capital must be properly drafted in order to achieve the desired objectives.

Examples of use

For example, one shareholder might hold 50 "A" participating shares, and another shareholder might hold 50 "B" participating shares, and the Articles of Association provide that the Board of Directors may allocate the amount of dividends on either class at its sole discretion. While normally each shareholder would be entitled to 50% of the dividends declared, by using discretionary shares the Board of Directors can determine the amount to be allocated to each class.

A similar result can be achieved with discretionary non-participating shares. For example, one shareholder might hold all of the Class "A" common shares, and another shareholder might hold 10 discretionary "B" preferred shares. In this situation, directors can declare a dividend in an amount they determine on the "B" shares, to the exclusion of the Class "A" shareholders. This is an "unlimited" discretionary dividend, as the amount of the dividend is at the discretion of directors, with no limit imposed in the articles. For tax reasons, following recent amendments to the Income Tax Act, discretionary non-participating dividends are less used when the shareholder is a corporation.

Identical categories

It should be noted that provincially incorporated companies may, under the Business Corporations Act, have multiple classes of shares with identical rights and restrictions. At the federal level, this is not expressly permitted, and two classes with different designations but identical rights and restrictions could be considered as one class. In this context, for federal companies, distinctions in rights and restrictions between discretionary classes should be provided for in the articles for greater certainty.

This type of share is used in several contexts. For example, they allow several shareholders to declare and pay dividends to each other according to the income each brings to the company, year after year. They are also widely used for tax planning purposes.