Redeemable vs. Retractable Shares (Share Redemption)

Both terms describe a buy-back right written into the share conditions in a corporation's articles:

• Redeemable shares give the corporation the right to buy the shares back, usually on notice and at a set price. It works like a call option held by the company.
• Retractable shares give the holder the right to require the corporation to buy them back. It works like a put option held by the shareholder.

The Ontario Business Corporations Act (OBCA) does not use the word retractable. Its definition of a redeemable share covers both: a share the corporation may purchase or redeem on its own demand, and a share the corporation is required by its articles to purchase or redeem at a specified time or on the demand of a shareholder. Many shares are both redeemable and retractable.

The price is fixed in the articles, as a dollar amount or by formula, often the fair market value of what was received for the shares plus declared but unpaid dividends. Redemption terms are typical of fixed-value preferred shares used in an estate freeze, investor shares and family holding structures. Our guide to share structure for a new Ontario corporation explains why it pays to authorize such a class at incorporation. Adding, removing or prejudicially changing redemption rights later requires articles of amendment approved by special resolution, and the affected class votes separately even if its shares are otherwise non-voting.

1. Read the share conditions. Confirm who can trigger the redemption or retraction, the price or formula, notice periods, whether partial redemptions must be pro rata and how payment is made.
2. Check the shareholder agreement. A shareholder agreement or unanimous shareholder agreement may require consents, set a funding schedule or limit timing.
3. Apply the solvency tests. The directors must be satisfied that there are no reasonable grounds to believe the payment breaches the OBCA tests described below, ideally on current financial statements.
4. Authorize and pay. The board passes a resolution redeeming the shares or accepting the retraction notice, and the corporation pays the price.
5. Adjust stated capital and cancel the shares. Under section 35, the corporation deducts the redeemed shares' proportionate part of the class's stated capital account. The shares are cancelled or, if the articles cap the number of authorized shares of that class, may be restored to authorized but unissued status.
6. Update records and report. Update the securities register and minute book, and report the deemed dividend on a T5 slip.

Every buy-back must pass a liquidity test and a balance-sheet test. The corporation cannot pay if there are reasonable grounds to believe it is, or after the payment would be, unable to pay its liabilities as they become due. The balance-sheet test depends on the transaction:

Directors who vote for or consent to a buy-back that breaches sections 30, 31 or 32 are jointly and severally liable to restore the amount paid to the corporation, and they can apply to court to recover it from the shareholder who received it. Our entry on directors' liability covers this exposure.

A retraction right does not override these tests: if the corporation cannot pass them, it cannot pay. Where the corporation has contracted to buy its own shares, section 36 makes the contract enforceable except to the extent the tests prevent performance. Until paid, the seller remains a claimant entitled to payment as soon as the corporation can lawfully pay, ranking behind creditors and higher-ranking shareholders but ahead of other shareholders in a liquidation.

Subsection 84(3) of the Income Tax Act applies whenever a corporation resident in Canada redeems, acquires or cancels its own shares in any manner whatever, other than in a winding-up or an ordinary open-market purchase. The amount paid above the paid-up capital (PUC) of the shares is deemed to be a dividend.

Paid-up capital is a tax figure that usually starts from the stated capital of the class under corporate law, adjusted by the Act, and is averaged across all shares of the class. Founders who subscribed at $1 per share have almost no PUC, so nearly the whole redemption price is a dividend. Shares issued in a section 85 rollover or a freeze often have nominal PUC for the same reason.

The capital gain side. The deemed dividend is excluded from proceeds of disposition, so the shareholder computes a capital gain or loss only on the remaining amount, normally the PUC, against the shares' adjusted cost base. A shareholder who bought shares from someone else at full value can end up with a dividend and an offsetting capital loss.

Three further consequences:

• The deemed dividend is non-eligible unless the corporation designates it as eligible, and a private corporation with a large enough capital dividend account can elect to treat it as a tax-free capital dividend.
• The lifetime capital gains exemption shelters capital gains only, so it cannot be used against a redemption dividend.
• When the redeemed shareholder is a corporation, the dividend is usually deductible, but subsection 55(2) can turn it into a capital gain where it exceeds the income earned that contributed to the gain (safe income). An exception applies to redemptions where no unrelated person acquires property or a significant interest as part of the series.

A corporation can take back shares in two ways under the OBCA. A redemption uses rights already in the articles: only redeemable shares qualify, and the price cannot exceed the redemption price or formula. A purchase for cancellation is a negotiated buy-back of any issued shares under section 30, at an agreed price, subject to the articles and the stricter balance-sheet test. For tax, both are subsection 84(3) transactions.

That trade-off drives shareholder buyouts: corporate money is cheaper to use, but a departing owner often prefers capital gains treatment. Our guides on removing or buying out a shareholder and shareholder buyout valuation cover the negotiation, and a buy-sell agreement often uses an insurance-funded redemption when a shareholder dies.

In 2019, Harjit Gill completed an estate freeze of Gill Precision Machining Inc., a Brampton manufacturer. He exchanged his common shares for 2,000,000 Class A preferred shares, redeemable by the corporation and retractable by him at $1 each, and his daughter Simran subscribed for new common shares. His freeze shares have nominal paid-up capital and adjusted cost base.

Now retired, Harjit gives notice in 2026 to retract 120,000 shares for $120,000. Before paying, the directors, Harjit and Simran, check the section 32 tests. The company pays its bills as they come due, and its realizable assets of $4.6 million would fall to $4.48 million after the payment, still above its $1.9 million of liabilities plus the $1.88 million needed to redeem the freeze shares that remain outstanding.

The board approves the retraction, reduces the Class A stated capital account and cancels the 120,000 shares. Almost all of the $120,000 is a deemed dividend under subsection 84(3), reported on Harjit's T5, with no meaningful capital gain. Each retraction also shrinks the frozen value that will be taxed as a deemed disposition when Harjit dies.