Since the Accounting Standards for Private Enterprises (“ASPE”) was introduced in 2011, private companies were required to present preferred shares issued under Sections 51, 85, 85.1, 86, 87 or 88 of the Income Tax Act (Canada) (“ITA”) at par, stated or assigned value as a separate line item in the equity section of the balance sheet. Additional disclosure was required to explain that these shares were redeemable at the option of the holder and the full redemption amount needed to be noted on the balance sheet as well.

The true purpose of this guidance was to maintain the consistency of the equity and liability split where the preferred shares were issued to freeze the value of the portion of the company owned by the controlling shareholders and issue new voting shares while still maintaining the same control structure.

However, in practice, this guidance was being applied to transactions that did not pertain to the above noted scenario (such as employee compensation plans, financing arrangements and management buy-outs).

In order to address these unintended consequences, the Accounting Standards Board (“AcSB”) has introduced updated ASPE guidance for year ends beginning on or after January 1, 2020. These new rules have removed reference to the specific sections of the ITA and state that companies that issue retractable or mandatorily redeemable shares in a tax planning arrangement (“ROMRS”) may choose to present those shares at par, stated or assigned value as a separate line item in the equity section of the balance sheet only when certain conditions are met. These conditions, referred to in totality as the “control condition” are as follows:

1. Control of the company issuing the ROMRS is maintained by the shareholder(s) receiving those shares,
2. No consideration is received by the company and only shares are exchanged, and
3. No other written or oral arrangement exists (including a redemption schedule) “that gives the holder of the shares the contractual right to require the [company] to redeem the shares on a fixed or determinable date or within a fixed or determinable period”.

To summarize: a company cannot simply apply this equity “at par” accounting to ROMRS because they are issued in accordance with specified Sections of the ITA. Rather, the resulting control condition must be satisfied.

Where a company previously applied this this equity accounting to a transaction that does not meet the control condition, the financial statements will like have to be restated – possibly resulting in a significant reallocation from equity to preferred share liability.

If you need guidance on how future planned transactions may affect your company’s financial statements, or on the implication of these new rules to past transactions, please do not hesitate to contact our team of accounting practitioners.