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4562-6:

ADMS 4562 - LECTURE 6


Last updated on September 24, 2015
This Lectures Topics and Recommended Problems
1. Taxation of Corporation Distributions (Deemed Dividend Rules)
1.1 Paid-up Capital
1.2 Capital Dividend Account
1.3 Summary of Different types of Corporate Distributions and their Tax
Treatment (Stock dividends, Dividends in Kind, Deemed dividends)
Readings
FIT Ch. 15
ITA 82, 83, 84, 89(1) 184(3)
Review Questions 2, 4, 5, Multiple Choice Questions 1, 2 & 5, Exercises 1 to 5
2. Winding up a Corporation after the Sale of Assets
3. Sale of Assets versus Shares: Considerations for the Vendor
4. Assets versus Shares: Considerations for the Purchaser
Readings
FIT Ch. 15, (Example Problem 15-4 and Example Problem 15-5, but SKIP Parts (B) to
(D) of the Example Problem in 15320)
SKIP 15400 on GST
Review Questions 7, 9, Multiple Choice Questions 3, 4 & 6, Exercises 6 to 8 (Skip Part
(D) of Exercise 8)
Problem Set: (in separate document)

TAXATION OF CORPORATE DISTRIBUTIONS (DEEMED DIVIDEND


RULES)

1.1

PAID-UP CAPITAL
WHAT IS THE PAID-UP CAPITAL (PUC) OF A SHARE?
THE PUC OF A CLASS OF SHARES = LEGAL STATED CAPITAL (LSC) OF THAT
CLASS SUBJECT TO ADJUSTMENTS found in the Act.
99% OF THE TIME THERE ARE NO ADJUSTMENTS.
WHAT IS THE LSC OF A CLASS OF SHARES?

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UNDER the Ontario Business Corporations Act (OBCA) AND the Canada Business
Corporations Act (CBCA), THE LSC OF SHARES ISSUED IS GENERALLY
= FMV OF THE NET ASSETS TRANSFERRED IN AS CONSIDERATION FOR THE
SHARES ISSUED 1(see Note at bottom of page*)
IN MOST CASES, CASH IS PAID FOR THE ISSUED SHARES, SO THE LSC AND
PUC IS THE ORIGINAL ISSUE PRICE.
The legal stated capital (LSC) is typically found on the companys balance sheet (i.e.,
share capital)
UNDER THE ACT [S. 89(1)] PUC OF A SHARE = AVERAGE PUC OF THE
CLASS
THIS MEANS THAT IF SHARES ARE ISSUED AT DIFFERENT TIMES, THE PUC
OF THE SHARES ARE AVERAGED
EXAMPLE:
X Ltd. issued 100 common shares for $1 each in 2001 to MR. A and 100 common shares
for $2 each in 2014 to MR. B. What is the PUC of each common share of X Ltd. today?
PUC:
100 x $1 =
$100
100 x $2=
$200
200
$300
$300/200 shares = $1.50 per common share
What is the ACB of each common share of X Ltd. owned by Mr. A and by Mr. B?
ACB per common share:
$1 for Mr. A
$2 for Mr. B
WHY DO WE CARE ABOUT PUC?
1. IF INCREASE IN PUC > INCREASE IN FMV OF NET ASSETS TRANSFERED IN,
THE SHAREHOLDER RECEIVES A DEEMED DIVIDEND: s. 84(1)
2. IN THE CASE OF A PRIVATE CORPORATION, A PAYMENT IN RESPECT OF A
REDUCTION OF PUC IS RECEIVED TAX-FREE: s. 84(4)

*Note: The Board of Directors of a Corporation can decide to use a lower amount for certain non-arm's length
transactions.
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3. PUC IS RECEIVED AS PROCEEDS ON A REDEMPTION OF SHARES: s. 84(3)


OR A WINDING-UP OF A COMPANY: s. 84(2)
- we will now look at these three reasons in more depth
1.11

Deemed Dividends S. 84(1)


IF INCREASE IN PUC > INCREASE IN FMV OF NET ASSETS TRANSFERED
IN, THE SHAREHOLDER RECEIVES A DEEMED DIVIDEND: S. 84(1)
If a person contributes cash or assets worth $7 to a company in return for shares with a
LSC and a PUC of $8, they are getting back too much PUC and will be deemed to have
received a dividend for tax purposes of $1 and the corporation will be deemed to have
paid a dividend of $1
- a subsection 84(1) deemed dividend from a taxable Canadian corporation received by
an individual is grossed up and included in income (eligible for dividend tax credit); if
received by a corporation, a section 112 deduction is available
- the ACB of the shares received is increased by the s. 84(1) deemed dividend: s. 53(1)
(b).
Note: that deemed dividends triggered under different subsections such as 84(2); 84(3);
and 84(4); (discussed later in these notes) are not added to the ACB of the shares
Example #1
Mary, the sole-shareholder, transfers land (FMV $100,000) and a mortgage ($20,000) to
her company and consideration of 100 shares with a LSC and PUC of $100,000 is
received. (Assume the PUC of all previously issued shares is also $1,000 per share.)
What is the increase in the net assets of the corporation? Is there a deemed
dividend? if so how much? What are the PUC and the ACB of the shares received?
What is the increase in the net assets of the corporation?
$80,000 ($100,000 - $20,000)
Is there a deemed dividend? How much?
Yes, there is a $20,000 deemed dividend under s. 84(1) because the increase in net assets
is < increase in PUC
What are the PUC and the ACB of the shares received?
The PUC of the shares received is $100,000. The ACB of the shares received is also
$100,000 [$80,000 plus $20,000 s. 84(1), 53(1)(b)]

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1.12

PUC Reduction S. 84(4)


IN THE CASE OF A PRIVATE CORPORATION, A PAYMENT IN RESPECT OF
A REDUCTION OF PUC IS TAX-FREE: s. 84(4)
A REDUCTION IN PUC BY A PRIVATE CORPORATION RESIDENT IN CANADA:
1. IS DISTRIBUTED TAX-FREE
2. REDUCES THE ACB OF THE SHARES: s. 53(2)(a)(ii))
3. ANY PAYMENT IN EXCESS OF PUC IS a deemed dividend: s. 84(4)
IN THE CASE OF A PUBLIC CORPORATION, generally speaking, the
ENTIRE PAYMENT IS A DIVIDEND (i.e., taxable): s. 84(4.1)
Example# 1
Cap Limited, a CCPC, has shares with a FMV of $435,000 and a PUC of $5,500. Cap
Limited is considering making a non-dividend payment (as part of a PUC reduction) of
$8,750 to its sole shareholder whose shares have an ACB of $17,500. Which of the
following statements is correct?
(a) The payment of $8,750 will result in $8,750 of income for the shareholder under s.
15(1).
(b) The payment of $8,750 will result in no tax consequences to the shareholder and the
company since it is a non-dividend payment.
(c) The payment of $8,750 will result in an immediate deemed dividend of $3,250. The
ACB of the shares will be unaffected.
(d) The payment of $8,750 will result in an immediate deemed dividend of $3,250. The
ACB of the shares will be reduced to $12,000.
The correct answer is (d)

Example #2
You own half of the shares of a private company. The PUC of all the shares is $2,000.
The ACB of your shares is $5,000 (you bought them last year from someone else). The
corporation has decided to reduce the paid up capital of the corporation and pay out
$2,800, in aggregate, to the shareholders. What amounts do you receive tax-free?
What amount do you receive as a dividend? What is the new ACB of your shares?
What amounts do you receive tax-free?
$1,000 (half the PUC of $2,000 since you own half the shares)
What amount do you receive as a dividend?
$400 [$2,800 x = $1,400 minus $1,000 (i.e., $2,000/2 (i.e., the PUC)) = $400 since you
own half the shares]
What is the new ACB of your shares?
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$4,000 ($5,000 ACB $1,000; i.e., 1/2 of $2,000 tax-free distribution, since you own half
of the shares)
1.13

Redemption of Shares S. 84(2) and S. 84(3)


PUC IS RECEIVED AS PROCEEDS ON A REDEMPTION OF SHARES BY A
PRIVATE CORP. (S. 84(3)) OR A WINDING-UP OF A COMPANY: S. 84(2)
PUC is returned tax-free, any excess is a deemed dividend. Also, there is a disposition
(of shares) which may trigger a capital gain or a capital loss to the shareholder
1. ON A REDEMPTION OF SHARES BY A PRIVATE CORP. (I.E., WHEN SHARES
ARE REPURCHASED BY A PRIVATE CORP.)
2. ON A WINDING-UP OF A COMPANY
PROCEEDS OF DISPOSITION MINUS ACB = CAPITAL GAIN OR LOSS
NOTES:
1. If a public company redeems its shares (via an open market purchase), the above rules
do not apply [s. 84(6)]. This course will focus on redemption of shares by private
corporations.
2. If a private company redeems its shares, the PUC is typically returned tax-free as
proceeds of disposition and any remaining amount is a deemed dividend [i.e., there is a 2
step procedure: 1) deemed dividend and 2) capital gain/capital loss].
Example #1
X Ltd. (a CCPC), redeems all of its 2,000 redeemable preference shares for $120 per
share. The PUC of each share is $100. How would the owner of 1 share, whose ACB is
$122, be affected by the redemption?
(a) The owner would have a $1 allowable capital loss.
(b) The owner would have a $2 allowable capital loss.
(c) The owner would have a $20 capital dividend.
(d) The owner would have a $20 taxable dividend and a $11 allowable capital loss.
The correct answer is (d)

Example #2
You own half of the shares of a private company. The PUC of all the shares is $2,000.
The ACB of your shares is $5,000 (you bought them last year from someone else). The
corporation decides to redeem your shares for $6,000. What are the tax consequences?
Redemption amount (RA) PUC = Deemed Dividend
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$6,000 - $1,000 (since own half the shares) = $5,000 Deemed Dividend
RA Deemed dividend = Adjusted proceeds of disposition
$6,000 - $5,000 = $1,000
Adjusted proceeds of disposition ACB = CG (CL)
$1,000 - $5,000 = ($4,000 CL)
1.14

Contributed Surplus
CONTRIBUTED SURPLUS RESULTS WHEN THE INCREASE IN THE FMV OF
NET ASSETS transferred into the corporation in return for shares of the corporation >
THE INCREASE in legal stated capital (LSC)
CONTRIBUTED SURPLUS CAN BE CONVERTED TO PUC UNDER S. 84(1)(c.3).
PLANNING: DO CONVERSION TO AVOID DEEMED DIVIDEND
Example #1
The sole shareholder of X Corp. transferred assets worth $38,400 to the corporation in
return for cash of $15,400 and preference shares with a legal stated capital of $21,000
(redemption and retraction value of $23,000). Which of the following statements is
correct?
(a) The shareholder will realize a $2,000 capital gain.
(b) The shareholder will realize a deemed dividend of $2,000.
(c) There will be a $2,000 increase in contributed surplus which can be converted to PUC
pursuant to par. 84(1)(c. 3) of the Act.
(d) The shareholder will realize a deemed dividend of $23,000.
The correct answer is (c)

Example #2
Net assets worth $80,000 are transferred to a corporation in consideration for shares with
a LSC of $75,000. These are the only shares issued by the corporation in that class. What
are the tax consequences if the shares are redeemed immediately for $80,000?
RA PUC = Deemed Dividend
= $80,000 - $75,000 = $5,000 Deemed Dividend
RA Deemed dividend = Adjusted proceeds of disposition ACB = CG or CL
$80,000 - $5,000 = 75,000 - $80,000 = $5,000 CL; $2,500 allowable capital loss
How can a conversion under s. 84(1)(c.3) help matters?

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It would increase the PUC by $5,000 which would reduce the deemed dividend and
capital loss to zero. Note: there is $5,000 of contributed surplus (prior to a s. 84(1)(c.3)
conversion)

1.2

CAPITAL DIVIDEND ACCOUNT S. 89(1)


WHAT IS IT?
AN ACCOUNT FOR PRIVATE CORPORATIONS =
1. Non-taxable portion of capital gains minus non-allowable portion of capital losses*;
2. Tax-free portion of eligible capital property (ECP) gains**;
3. Capital dividends received; and
4. Life insurance proceeds received minus ACB*** of policy
minus
Capital dividends paid
* Recall: that with charitable donations of marketable securities to a registered charity (or
other qualifying institution) the taxable portion of the capital gain is now 0%, and in these
cases 100% of the capital gain is added to the capital dividend account
The April 21, 2015 federal budget has reduced the taxable portion of the capital gain to
0% (starting in 2017) for sales of private company shares and real estate, occurring in
2017 and thereafter, as long as:
1) all the cash proceeds are donated to a registered charity (or other qualifying institution)
within 30 days after the disposition; and,
2) the private company shares or real estate are sold to an arms length purchaser. (The
purchaser must be at arms length with both the seller and the registered charity.)
If only a portion of the cash proceeds are donated then that portion of the capital gain will
be tax-free. The tax-free portion will add to the CDA
** The tax-free portion of ECP gains only adds to the capital dividend account at yearend. Hence, capital dividends based on such ECP gains should only be paid after year-end
*** The ACB is typically nil (i.e., $0) for (simple) term life insurance
WHY DOES IT EXIST?
INTEGRATION - IT ALLOWS TAX-FREE AMOUNTS TO FLOW OUT TAX-FREE
TO SHAREHOLDERS
WHY IS IT IMPORTANT?
DIVIDENDS ELECTED TO BE PAID FROM THE CAPITAL DIVIDEND ACCOUNT
ARE TAX-FREE TO CANADIAN RESIDENTS: s. 83(2)

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ADMINISTRATIVE DETAILS
YOU MUST ELECT TO PAY A CAPITAL DIVIDEND BEFORE YOU PAY IT
(SPECIAL FORMS MUST BE FILED BEFORE IT IS PAID)
EXCESS CAPITAL DIVIDEND IS SUBJECT TO A PART III PENALTY TAX OF 60%
S. 184(3) ALLOWS A CORP. TO AVOID the 60% PENALTY IF IT ELECTS TO
TREAT THE DIVIDEND AS A TAXABLE DIVIDEND WITHIN 90 DAYS OF DATE
OF MAILING OF NOTICE OF ASSESSMENT RE THE 60% PENALTY TAX SHOULD ALWAYS ELECT (if an excess capital dividend is paid)
EXAMPLES OF USES OF S. 184(3) ELECTION ON EXCESS CAPITAL DIVIDENDS
1. IF capital gain (CG) ON SALE OF REAL ESTATE IS REASSESSED AS INCOME
AND NON-TAXABLE PORTION OF THE GAIN HAS ALREADY BEEN PAID OUT
AS A CAPITAL DIVIDEND (AND TAXPAYER IS NOT DISPUTING THE
REASSESSMENT)
2. IF PART OF THE DIVIDEND ON A SHARE REDEMPTION IS A CAPITAL
DIVIDEND AND PART IS NOT and a capital dividend in excess of the capital dividend
account balance has been paid.
PLANNING:
1. PAY OUT a CAPITAL DIVIDEND prior to selling capital assets at a loss
- SINCE 1/2 OF THE capital loss (CL) WILL typically REDUCE THE CAPITAL
DIVIDEND ACCOUNT
2. DELAY PAYMENT OF CAPITAL DIVIDEND IF UNCERTAIN WHETHER GAIN
IS CAPITAL OR INCOME
- WAIT TO SEE IF REASSESSED

1.3

SUMMARY OF DIFFERENT TYPES OF DIVIDENDS


Dividends can be paid (in cash, stock or property) or deemed to be paid (by s. 84).
Dividends can be taxable or capital (tax-free). Some taxable dividends may be eligible
dividends (entitled to an enhanced (1.38) gross-up in the hands of individuals). Here are
some definitions:
Stock dividends
Stock dividends are dividends paid in the companys stock. The amount: of a stock
dividend that is included in the recipients income is the increase in the PUC: s. 248(1),

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stock dividend and amount. The cost (i.e., ACB) of the share received is the amount
of the dividend
Dividends in Kind
A dividend paid in kind is a dividend paid with corporate property (i.e., assets) other than
cash. The corporation would have a disposition at FMV and would pay tax on any taxable
capital gains and/or recapture (losses are denied if the property is distributed to a
controlling shareholder or other affiliated person (discussed in a future lecture))
Deemed Dividends
As discussed in this lecture, a corporation can also be deemed to have paid a dividend by
increasing paid-up capital (s. 84(1)) or redeeming shares (s. 84(3)) or winding up a
corporation (s. 84(2)). If the payment on a PUC reduction exceeds the PUC, there will
also be a deemed dividend.
Example comparing tax consequences of various types of dividends paid in 2015 by
a taxable Canadian corporation (cash vs. stock vs. dividends paid in kind).
Taxable
dividend
(non eligible
dividend)

Tax Consequences
to an Individual
Shareholder
Taxable Income =
Grossed up
dividend (i.e., x
1.18)
DTC = 13/18 of
gross up

Part I Tax
Consequences to
Corporate
Shareholder
(Taxable income
after s. 112
deduction)

Cost of
property
received by
shareholder

Tax
consequences
to corporation
(Payer)*

$100 cash
dividend

$118
DTC = $13

$100

None - no
deduction
for cash paid

Stock dividend $118


DTC = $13
(PUC increase
= $100)

$100

PUC of shares
issued is
increased by
$100

Land (FMV
$118
$100; ACB
DTC = $13
to corporation:
$60)

$100

CG= $40
TCG = $20

* Note: there will also be a dividend refund to the payer if the payer is a private company
with a positive RDTOH balance

2.

WINDING UP A CORPORATION AFTER THE SALE OF ASSETS

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10

15200 of Chapter 15 of FIT provides good examples and exhibits which show how a
winding up works. The problem set in the separate document is also a good problem. The
steps are summarized at the end of Chapter 15 (15240). There are basically two steps:
1. Using the chart format set out in FIT, compute the income and corporate tax on the sale
of the companys assets and the RDTOH and the capital dividend account balance.
2. Compute the amount available for distribution to shareholders after payment of taxes
and other liabilities and receipt of dividend refund.
3. Distribute the funds to shareholders, declaring the maximum capital dividends
2.1

Advantages of Not Winding Up Corporation


A company may wish to sell all its assets and not wind-up. It can then re-invest the cash
in new assets (either active business assets or investment assets). The advantages of not
winding up include the advantages available to corporations discussed throughout this
course including limited legal liability protection for shareholders, the small business
deduction on Canadian active business income, the capital gains exemption (if the shares
are QSBC shares) and avoiding U.S. estate tax on U.S. assets (not discussed in this
course).
If the shareholder wants to defer the tax on the deemed dividend triggered on the wind up
then he/she may choose not to wind-up the corporation. An individual will eventually pay
tax on any accrued capital gain on death (if they dont qualify for the spousal rollover) as
discussed in lecture 10.
The taxation of investment income earned by private corporations was discussed in
lecture 4.

3.

Sale of Assets versus Shares: Considerations for the


Vendor
15300 of Chapter 15 of FIT provides good examples and exhibits which show how you
compare
1. The after-tax cash flow from the sale of shares (with or without the QSBC) capital
gains exemption; to
2. The after-tax cash flow from the sale of assets.
Ignore Parts B - D of the Example Problem (in 15320).
Assets versus Shares
As discussed in lecture 5, an owner of a corporation (who is an individual) who is
considering selling his/her business would typically want to sell his/her shares of the
corporation if the shares are QSBC shares and he/she has unused capital gains exemption
room. This would allow the seller to benefit from the capital gains exemption. Receiving
an $813,600 (in 2015) tax-free capital gain can save shareholders who qualify hundreds

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11

of thousands of dollars of income tax. Recall that only individuals can get the capital
gains exemption.
However, prospective purchasers will often prefer to purchase the assets of the business
as opposed to the shares of the corporation as discussed below.
Vendors may have their corporation sell its assets and then the vendor can either continue
with the corporation (which now has cash to re-invest) or wind-up the company as
discussed above.
The seller will compute his/her after-tax net cash retained from each option to determine
whats best for him/her. If the purchaser buys assets, the corporation will sell its assets,
pay its corporate tax and then the personal tax that will be triggered when the corporation
distributes its cash out to the shareholder will need to be computed.
If the purchaser buys shares, the shareholder will compute his/her net cash retained after
paying any tax on the taxable capital gain. If the seller is an individual, the shares are
QSBC shares, and the individual has remaining capital gains exemption room, some or
all of the capital gain can be tax-free.

4.

Assets versus Shares: Considerations for the Purchaser


Prospective purchasers will often prefer to purchase the assets of the business as opposed
to the shares of the corporation for the following reasons:
1) Buying all of the shares of a company means that you acquire control over the net
assets of the company (i.e., the assets less the liabilities). Hence, the purchaser may be
buying/obtaining liabilities (including contingent liabilities that may not be known at the
time of sale) that the purchaser does not want; and
2) Buying assets allows the purchaser to typically have a higher tax value for assets
purchased since the price paid (i.e., FMV) for these assets will typically become the
purchasers tax value. Buying all of the shares of a company means that the company
keeps its current (and typically lower) tax value balances
Accordingly purchasers will often pay less for the shares of a corporation than they
would pay for the assets.
The purchaser can be an individual or a corporation. (A partnership or a trust can also
purchase shares; partnerships and trusts are discussed in future lectures.) The advantage
of purchasing shares using a holding company (i.e., the purchaser is a corporation) is the
possibility of: (a) amalgamating the 2 companies into 1 company or winding up the
subsidiary into the parent after the purchase of shares; and (b) using the 88(1)(d) bump to
increase the ACB of non-depreciable capital property formerly owned by the subsidiary.
Amalgamations and wind-ups and the 88(1)(d) bump will be discussed in lecture 8.

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