Chapter 16

Corporate Distributions, Asset Sales, and Winding Up

 Corporate Surplus Balances
Tax Basis Balance Sheet
ASSETS LIABILITIES

SHARE CAPITAL
Paid-up Capital (PUC)
EQUITY
1. Capital Dividend Account
2. Undistributed Surplus (Retained earnings)
 Paid-Up Capital of Shares

Tax Concept:
• Contribution by shareholder from after-tax funds on the
initial investment in corporate shares
• Can be returned to shareholder tax-free

Accounting: Share capital

Corporate Law: Legal stated capital

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 PUC vs. ACB
PUC ACB
Calculated at corporate level: Calculated at shareholder level:
• Based on capital contributed • Based on amount paid for shares
• to corp. • Unique to each shareholder
• Averaged among all
shareholders of class based on
shares held Considered on the
disposition of shares.
Can be withdrawn free
of deemed dividend.
 Example

• Rob incorporates Clarkco. in 2013 and paid $5,000 for

1,000 shares.

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 Result

• Rob’s ACB = $5,000

• Clarkco.’s PUC total = $5,000
• Rob’s PUC = $5,000

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 Example
• In 2021, John buys 1,000 shares of Clarkco. for $75,000.
 Result

• Clarkco. PUC total - $80,000

• Rob’s shares ACB - $5,000, PUC of $40,000
• John’s ACB - $75,000, PUC of $40,000

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 Paid-Up Capital of Shares

Technical Definition:
• Determined in accordance with corporate law (Legal Stated
Capital)
• May be stated capital of shares, par value of shares, or consideration
paid for the shares
• Averaged among shareholders of entire class
 Paid-Up Capital of Shares

Effect of PUC on redemption of shares

• Redemption occurs when corporation buy back its own
shares
• PUC relevant to any shareholder on redemption or
cancellation of shares
• Used to determine deemed dividend on redemption
 Share Redemption

Two-step process:
1. Deemed dividend if the redemption proceeds exceed the PUC
of the shares being redeemed.

2. Capital gain or capital loss:

1. Proceeds of disposition (Redemption amount) – Deemed dividend =
Adjusted proceeds of disposition
2. Capital gain or loss = Adjusted proceeds of disposition – Adjusted cost
base
 Example

• Shares were redeemed right after John bought his

shares.
 Redemption of Rob’s Shares

Step 1: Deemed Dividend

Redemption Amount $75,000
Less: PUC of shares redeemed 40,000
Deemed dividend on redemption $35,000

Step 2: Capital gain (loss)

Proceeds of disposition (redemption amount) $75,000
Less: deemed dividend 35,000
Adjusted proceeds of disposition $40,000

Adjusted proceeds of disposition $40,000

Less: adjusted cost base 5,000
Capital gain $35,000
 Paid-Up Capital of Shares

PUC Distributions
• Act very protective about amounts added to PUC
• Thus, additions to PUC must be the value of property contributed to
corporation with after-tax funds
• If not, a deemed taxable dividend will result

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 Capital Dividend Account

Purpose: To complete integration of corporate and

personal income tax on capital gains and similar
receipts.
 Capital Dividend Account

Basic Components:
+ Non-taxable portion of net capital gains
+ Capital dividends received from another corporation

+ Life insurance proceeds on death received by corporation

- Capital dividends paid

 Capital Dividend Account

“The Period” normally starts on the later of:

• The date of incorporation and
• January 1, 1972
 Capital Dividend Account

Filing the Capital Dividend Election

• Must be filed when dividend paid or becomes payable using T2054.
 Capital Dividend Account – Exercise 1
• The following capital properties have been sold by a Canadian private
corporation during the year ended December 31

A B C
Proceeds of disposition $4,000 $1,000 $2,000
Cost 2000 2000 2000
Selling expenses 400 100 200

• Compute the effect of the dispositions on the capital dividend

account?
 Solution

A B C
Proceeds of disposition $4,000 $1,000 $2,000
Less: adjusted cost base (2000) (2000) (2000)
Selling expenses (400) (100) (200)
Capital gain (loss) $1600 (1100) (200)
Adjustment to CDA (1/2 of Capital gain (loss) $800 $(550) $(100)
 Corporate Surplus Balances
Tax Basis Balance Sheet
ASSETS LIABILITIES

SHARE CAPITAL
Paid-up Capital (PUC)
EQUITY
1. Capital Dividend Account
2. Undistributed Surplus
 Use of Corporate Surplus Accounts

Taxable Dividends Received or Deemed to be Received:

• Corporations
• Included in income for tax purposes
• If declared by Canadian corporation, dividend is deductible
• Dividend may be subject to Part IV tax on portfolio dividends

• Individuals
• Subject to gross-up and tax credit system
 Use of Corporate Surplus Accounts

Source of Taxable Dividends

• CCPC may designate an eligible dividend to the extent of its
GRIP
• GRIP(General rate income pool) balance is:
+ CCPC GRIP balance at end of previous year;
+ After-tax earnings that have not benefited from small business
deduction and are not considered Aggregate Investment Income eligible
for refundable tax;
+ Eligible dividends received by the corporation; and
₋ Eligible dividends paid.
 Use of Corporate Surplus Accounts

Cash or Stock Dividends

• Stock dividend is taxed as a taxable dividend paid in cash
• Amount of dividend deemed to be equal to the increase in
PUC due to stock dividend
 Stock Dividend - Example
• On June 30, 2023, the shareholders’ equity section of the balance sheet of
XYZ Inc is as follows:
• Common stock (23,400 shares outstanding) $351,000
• Retained Earnings 462,000
• Total shareholders’ equity 813,000
• On this date, the company declares a 5% stock dividend. At this time the
FMC of the shares are $25. What is the impact on PUC after stock dividend
issue
• PUC increases by 23400 X 5% X 25 = $29,250
• Total PUC after the stock dividend issue = 351,000 + 29,250 =$$380,250
 Use of Corporate Surplus Accounts

Dividends in Kind
• Dividends paid in assets of the corporation
• Results in:
1. Corporation deemed disposed of assets at FMV (capital gain/loss realized)
2. Shareholders deemed to acquire assets at FMV
3. Corporation considered to have paid, and shareholders considered to have received
a dividend equal to the FMV of assets distributed
 Dividends in Kind - Example
• XYZ Ltd., a private corporation owns shares in PC inc. The shares have
ACB of $600,000 and FMV of $1,200,000. XYZ decides to distribute
the PC inc. shares as a dividend in kind to its shareholders.
• XYZ’s taxable capital gain = 1,200,000 – 600,000 = $600,000
• Individual shareholders taxable dividend = $1,200,000
 Deemed Dividends

• Any distribution made by a corporation to a shareholder in

excess of PUC and not elected as a capital dividend or
declared as a taxable dividend will be deemed to be a
dividend that will be taxable.
Simple Equity Distribution
PUC $xxx ↓ Not taxable as a dividend
Capital Dividend Account ↓ Not taxable by election of capital dividend
xxx

Retained Earnings xxx ↓ Taxable Dividend (declared or deemed)

 Deemed Dividends

• On increase in PUC
• if increase in PUC>FMV property received
• On winding-up
• On redemption, acquisition, or cancellation of shares
• On reduction of PUC
• if FMV property received>PUC reduction
 Deemed Dividends

On increase in PUC (ssec. 84(1))

• Deemed dividend may occur if corporation increases PUC with no
equivalent increase in net assets.
• Deemed dividend may arise on the sale of property to the corporation where
the paid-up capital of the shares issued exceed the FMV of the property
transferred to the corporation.
• Deemed dividend added to the ACB of the shareholders shares
• No deemed dividend if:
a. Increase in PUC is from stock dividend
b. Increase in PUC is a result of an equivalent or greater increase in net assets at FMV
received by corporation
c. Increase in PUC of one class of shares and corresponding decrease in PUC of another
class
d. Corporation converts contributed surplus that arose on the issuance of shares into PUC
 Deemed Dividend - Example
• At beginning of the current year, GM inc. has 126,000 shares of common
stock issued and outstanding. The shares were originally issued at $10.50
per share, or $1,323,000 in total with all of this amount added to legal
capital and therefore PUC. During the current year, the company issue
40,000 new shares to settle a debt of $450,000. the fair market value of the
share at that time was $12.70 per share.
• Shortly after the new share issue Mr. Sue sells 5000 shares at $13.42 per
share. The shares were purchased at the time of original issue.
• Required:
• What are income tax consequences to GM’s shareholders and to Mr. Sue.
 Solution
• PUC of the new shares (40,000 X 12.70) $508,000
• Increase in net assets (debt reduction) (450,000)
• Deemed dividend $58,000

• Deemed dividend would be allocated proportionally to all shares outstanding: 58000/

(126,000+40,000) = $0.35
• Original issue price of the share would be = 10.50 + 0.35 = $10.85
• Mr. Sue Sale of shares:
• POD (13.42 X 5000) =$67,100
• ACB (10.85 X 5000) (54,250)
• Capital gain 12,850
• Taxable capital gain $6,425
 Deemed Dividends

On redemption, acquisition, or cancellation of shares (ssec. 84(3))

• Deemed dividend to the extent of the excess of the amount
paid by the corporation on redemption over the PUC of the
shares
• In addition to the deemed dividend, there may also be a
capital gain.
 Redemption of Shares

Step 1: Deemed Dividend

Redemption amount $xxx
Less: PUC of shares redeemed xxx
Deemed dividend on redemption xxx

Step 2: Capital gain (loss)

Proceeds of disposition (redemption amount) $xxx
Less: deemed dividend xxx
Adjusted proceeds of disposition $xxx

Adjusted proceeds of disposition $xxx

Less: adjusted cost base xxx
Capital gain (loss) $xxx
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 Redemption of Shares - Example
• Shares with Paid-up capital of $0 and adjusted cost base of $2000 are
redeemed for $5000.

Solution:
Deemed dividend: Redemption price – Paid-up capital = 5000 – 0 =
$5,000
Adjusted proceeds = Redemption price – Deemed dividend = 5000 -
5000 = $0
Capital loss: Adjusted proceeds – ACB = 0 – 2000 = $2000
 Redemption of Shares - Example
• Shares with paid-up capital of $3,000 and an adjusted cost base of
$2,000 are redeemed for $5,000.
• Solution:
• Deemed dividend: 5000 – 3000 = $2000
• Capital gain: Adjusted proceeds – ACB = (5000 – 2000) – 2000 =
$1000
 Redemption of Shares - Example
• Mr. Andrews owned Class A special shares of Atlantis Ltd. with the following characteristics:

Fair market value $60,000

Cost 20,000

Paid-up capital 10,000

• These shares were redeemed. What are the tax consequences of the redemption to Mr.
Andrews?
 Solution
• Redemption amount $60,000
• Less: Paid-up capital (10,000)
• Deemed dividend $50,000

• Capital gain (loss):

• Proceeds of Disposition (redemption amount) $60,000
• Less: deemed dividend (50,000)
• Adjusted proceeds of disposition 10,000
• Less: Adjusted cost base (20,000)
• Capital Loss (10,000)
 Redemption of Shares

• Denied Capital Loss

• If there is a capital loss on the redemption of shares, loss may be denied
due to “stop-loss” rule
• Applies if corporation and shareholder are “affiliated”(control)
immediately after redemption
• If denied, capital loss is added to ACB of any shares that redeeming
shareholder has
• Affiliated definition: shareholder and the redeeming corporation are
affiliated if the shareholder and/or his or her spouse or common-law
partner control the redeeming corporation.
 Deemed Dividends

On reduction of PUC
• Corporation returns some of the shareholders’ capital
without redeeming any of the issued shares
• Payment (FMV property ) received is in excess of available
PUC is a deemed dividend
 Capital Dividend - Revisited

• Private corporation can elect to treat actual or deemed

dividend as being distributed from capital dividend account if
the company has a capital dividend account balance.
• Received tax-free by shareholder

• Penalty under Part III of 60% of excess if the election is in

excess of Capital Dividend Account.
Asset Sales and Winding-Up a Canadian Corporation

Assets and liabilities transferred to

shareholder at FMV

Shares are cancelled

Corporation ceases to exist

 Distribution on Wind-Up
Funds available
for distribution
on winding-up
PUC returned
Deemed Dividend
as a capital
[ssec. 84(2)]
receipt

Used with ACB

of these shares Capital Dividend
to compute capital
gain/loss
Taxable Dividend

Subject to gross-up, tax credit

system for taxable dividends Distributed tax-free to the
[ssec. 82(1)] shareholders [ssec. 83(2)]
 Winding-up – disposition of net assets
• STEP 1: Disposition of assets at FMV to determine business
income and taxable capital gains

• STEP 2: Disposition of assets at FMV to determine Capital

dividend account and NERDTOH

• STEP 3: Calculate after-tax distribution

• Determine proceeds
• Calculate tax on disposition of assets
• Calculate available dividend refund
• Determine amount available after liabilities are paid
 Deemed Dividend on Winding-UP
• Timing the winding-up of the corporation

• Components of winding-up distribution:

• STEP 1: Calculate deemed dividend on winding up
• Elect available capital dividend
• Determine remaining taxable dividend

• STEP 2: Calculate capital gain/loss on share disposition

Deemed Dividend on Winding-UP- Example
• Twlight Ltd., a CCPC with no GRIP balance has been wound up this
year and its only shareholder has surrendered her shares. She
received $30,000 in total from the corporation for her shares which
had a cost to her equal to their paid-up capital of $2000. The
company had a capital dividend account balance of $4,500. All
business income of the CCPC has been taxed only at the low rate and
therefore, the company does not have a GRIP balance.
• Required:
• What are the tax consequences to the shareholder if she will be taxed
on any income from the winding-up at a combined (33%) federal and
(17%) provincial marginal rate of 50%
 Solution
• Deemed taxable dividend to Shareholder:
• Funds available to distribution $30,000
• Less: paid-up capital (2000)
• Deemed dividend on winding up 28,000
• Less: capital dividend elected (4,500)
• Deemed taxable dividend $23,500
• Taxable capital gain to shareholder
• Proceeds on winding-up 30,000
• Less: Deemed dividend (28,000)
• Adjusted proceeds of disposition 2,000
• Cost (2000)
• Capital gain Nil
• Taxable Capital gain Nil
• Net cash Retained =30000 – ( 23, 500 X( 1.15 X 0.50 – 0.15) = 20,013
 Asset Versus Share Sales

• Capital gain on shares sold

Share Sale • Potential use of CGE
• After-tax cash available to individual

• Business income, TCGs on assets sold

Asset Sale by the corporation
• After-tax cash available in corporation
• Individual must wind-up or retain
corporation and make distributions to
access cash
Analysis of Decision - Sale of Assets Versus Sale of Shares

Steps:
Vendor’s Decision:
Sale of Assets:
1. Dispose of all assets at FMV and follow winding-up
procedures
2. Determine the net after-tax cash retained by the shareholder
on sale of assets after the winding-up
 Analysis of Decision - Sale of Assets Versus Sale of Shares

Steps:
Vendor’s Decision:
Sale of Shares:
1. Based on net after-tax cash retained from sale of assets, calculate
the minimum share price acceptable to shareholder.
P – t [ ½ (P – ACB) – CGD] = Net after-tax cash

2. Consider payment of a tax-free dividend from the CDA before

sale of shares.
* Note CGD stands for Capital Gains Deduction
 Analysis of Decision - Sale of Assets Versus Sale of Shares

Steps:
Purchaser’s Decision:
Purchase of Assets:
1. Determine after-tax cost of purchasing assets at FMV.
• Deduct from the cost of assets the tax savings available from PV of future CCA from step up in
cost values to FMV
• Deduct from the cost of assets the PV of the tax cost of future dispositions of assets
purchased (depending on timing)
Shares:
2. Determine price for shares purchaser would pay to have the after-tax
cost of the shares equal to the after-tax cost of purchasing the assets.
 Review Questions
• Exercise 2
• Exercise 4
• Exercise 6
• Problem 1
• Problem 2