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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.
Copyright Joanne Magee/Jason Fleming
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1.12
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?
Copyright Joanne Magee/Jason Fleming
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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
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
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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
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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
$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.
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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
3.
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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.