Deemed Dividend | |||||||||||||||||
Whenever a corporation carries out transactions that affect its capital stock, it is necessary to determine whether this has tax consequences for the shareholders. The ITA contains rules designed to ensure that shareholders | |||||||||||||||||
receive the corporation's surplus as dividends for tax purposes, regardless of how these surpluses are transmitted to the shareholders. Section 84 describes situations that will give rise to a deemed dividend and explains how to calculate it. | |||||||||||||||||
For tax purposes, a deemed dividend is considered a real dividend, and it will therefore be grossed up and will entitle the shareholder to a dividend tax credit where the shareholder is an individual and the corporation is resident in Canada. | |||||||||||||||||
An election can also be made for this dividend to be payable on the capital dividend account where the corporation has such an account. | |||||||||||||||||
1. When the paid-up capital (PUC) of the shares of the corporation is increased artificially, such as when the shares are issued for a PUC greater than the FMV of the property transferred to the corporation as consideration for their issuance. | |||||||||||||||||
The deemed dividend is equal to the amount of the artificial increase of the PUC, and the ACB of the shares affected by the artificial increase of the PUC is increased by the amount of the deemed dividend. | |||||||||||||||||
2. When the corporation distributes funds or property to its shareholders on its winding-up or in a reorganization. The amount of the deemed dividend is then equal to the amount by which the value of the distributed property exceeds | |||||||||||||||||
the reduction of the PUC of the shares. | |||||||||||||||||
3. When the corporation redeems shares of its capital stock or purchases them by mutual agreement. | |||||||||||||||||
The deemed dividend is equal to the excess of the amount received for the share redemption or purchase over the PUC of the shares. | |||||||||||||||||
This is by far the most common situation that you will encounter in practice. In this case, there is also a disposition of the shares, | |||||||||||||||||
and it is necessary to calculate the capital gain or loss on the disposition in addition to the deemed dividend. However, in this calculation, the amount of the deemed dividend is excluded from the POD of the shares. | |||||||||||||||||
4. When the corporation pays an amount to its shareholders in a reduction of the PUC of its shares. There will be a deemed dividend if the amount paid to the shareholder exceeds the PUC of the shares. Any amount received that is not | |||||||||||||||||
considered a deemed dividend reduces the ACB of the shares. | |||||||||||||||||
Claude Carpentier is the sole shareholder of Detrek Ltd., which is a CCPC. Detrek Ltd.'s balance sheet as at December 31, 2007, was as follows: | |||||||||||||||||
Assets | $200,000 | ||||||||||||||||
Liabilities | $50,000 | ||||||||||||||||
Shareholder's equity | |||||||||||||||||
100 Class A shares, without par value, voting and participating | 50,000 | ||||||||||||||||
Retained earnings | 100,000 | 150,000 | |||||||||||||||
$200,000 | |||||||||||||||||
The 100 Class A shares were issued to Claude at the time of incorporation for a consideration of $50,000. | |||||||||||||||||
Claude wants to purchase a vacation condo at a cross-country ski resort. He needs $30,000 right away and wonders whether he can withdraw that amount tax-free. | |||||||||||||||||
As Claude's tax advisor, explain how he should proceed in order to withdraw $30,000 tax-free from Detrek Ltd. | |||||||||||||||||
The PUC and ACB of the 100 Class A shares held by Claude is $50,000. | |||||||||||||||||
Claude can withdraw $30,000 from Detrek Ltd. if, taking care to observe the applicable corporate law, he carries out a reduction of the PUC of the Class A shares for $30,000. | |||||||||||||||||
Such a reduction will be subject to the provisions of subsection 84(4). Under that subsection, there would be no deemed dividend, since the $30,000 reduction does not exceed the PUC of the Class A shares before the reduction. | |||||||||||||||||
Under subparagraph 53(2)(a)(ii), the ACB of the Class A shares for Claude would be reduced by $30,000. | |||||||||||||||||
Artifical Increase in PUC | |||||||||||||||||
Deemed Divided 84(1) | |||||||||||||||||
Increase of PUC of shares received | xx | ||||||||||||||||
increase in net asset(FMV ) | <xx> | ||||||||||||||||
Deemed Divided 84(1) | xx | ||||||||||||||||
Reduction in PUC | |||||||||||||||||
Deemed Dividend 84(4) | |||||||||||||||||
Amount paid | xx | ||||||||||||||||
reduction in PUC | <xx> | ||||||||||||||||
Deemed Divided 84(4) | xx | ||||||||||||||||
Loan To Shareholders | |||||||||||||||||
If the loan remains unpaid at the end of the year following the taxation year in which the loan is made, the loan, or the balance of the loan that is unpaid at that time, must usually be included in the income of the person receiving the loan. | |||||||||||||||||
The inclusion in income takes place in the taxation year (the calendar year for an individual) in which the loan was made. Subsequently, this person may receive a deduction in computing his income each year in which he makes repayments. | |||||||||||||||||
The deduction allowed will be equal to the amount repaid. [See subsections 15(2) and 15(2.6), and paragraph 20(1)(j).] | |||||||||||||||||
Non Arm Length Transactions | |||||||||||||||||
When the benefit results from a transfer of property from the corporation to the shareholder for an amount less than its FMV, the corporation will be deemed to have disposed of the property at its FMV. | |||||||||||||||||
When the benefit results from the transfer of property of the shareholder to the corporation for an amount exceeding its FMV, the ACB of the property for the corporation will be limited to the FMV. | |||||||||||||||||
PUC | Paid Up Caital | ||||||||||||||||
the amount that is contributed to the corporation on the issuance of the shares as entered in the legal records of the corporation (legal capital). | |||||||||||||||||
The PUC of a share is determined by class. It is calculated at a specific time, taking account of all the shares issued in the class at that time, and then distributed equally among all shares issued and outstanding in the class. Thus, | |||||||||||||||||
the PUC of a share is the average PUC of all shares in the class. | |||||||||||||||||
PUC represents the amount that a corporation can return to its shareholders as a tax-free return of capital. It is the critical value for transactions between a shareholder and the corporation. | |||||||||||||||||
The value of PUC may result in deemed dividends, as well as capital gains or losses when a shareholder returns shares to a corporation either on a winding-up or redemption. PUC is calculated without reference to the ITA. | |||||||||||||||||
Martin owns 2,000 Class A shares of Park Inc., which he acquired in 1997 for $60,000 from Maxine. There are currently 10,000 Class A shares issued and outstanding. These shares were issued on three occasions: | |||||||||||||||||
1982 | 2,500 shares for | $25,000 | |||||||||||||||
1986 | 2,500 shares for | $45,000 | |||||||||||||||
2000 | 5,000 shares for | $250,000 | |||||||||||||||
What was the PUC and the ACB of the 2,000 Class A shares owned by Martin? | |||||||||||||||||
a. in 1997 | |||||||||||||||||
b. in 2007 | |||||||||||||||||
a. | 1997 | PUC: $28,000 | ($70,000 × 2,000 ÷ 5,000) | ACB: $60,000 | |||||||||||||
b. | 2007 | PUC: $64,000 | ($320,000 × 2,000 ÷ 10,000) | ACB: $60,000 | |||||||||||||
Artifical Increase in PUC | (happen when rollover) | ||||||||||||||||
arise when the PUC of the issued shares of the class of shares is increase without : | |||||||||||||||||
1. A corresponding increase in the value of corporation's assets | |||||||||||||||||
2. A corresponding decrease in the value of of net liabilities | |||||||||||||||||
3. A corresponding increase in PUC of another class of shares | |||||||||||||||||
Reduction in PUC | (happened when shareholder takes out money ) | ||||||||||||||||
where there is reduciton in PUC without a reduction in #of share, a deemed dividend may result if amount paid th S/H is > PUC reduction | |||||||||||||||||
Alan has transferred, by rollover, a piece of land that is capital property to Syndrome Ltd. The ACB of the land is $10,000 and the FMV is $25,000. The agreed amount is set at $10,000. | |||||||||||||||||
As consideration for the land, Alan has received from Syndrome Ltd. a $10,000 note and preferred shares redeemable at $15,000, with a PUC of $15,000. | |||||||||||||||||
What is the PUC of the shares received by Alan, from a tax standpoint? | |||||||||||||||||
When the agreed amount, namely $10,000, is attributed to the consideration received by Alan, an amount of $10,000 is first attributed to the NSC, namely the note which then has an ACB of $10,000. | |||||||||||||||||
For the preferred shares, no amount is attributed as ACB; moreover, the PUC is reduced to zero. | |||||||||||||||||
The reduction is calculated as follows: | |||||||||||||||||
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where | |||||||||||||||||
A = | Increase in the PUC of all shares issued on acquisition of the land by Syndrome Ltd. = $15,000 | ||||||||||||||||
B = | Agreed amount – FMV of the NSC = $10,000 - $10,000 = $0 | ||||||||||||||||
C = | increase in the PUC of the preferred shares received by Alan = $15,000 | ||||||||||||||||
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The legal PUC of the preferred shares received by Alan, which is $15,000, is therefore reduced by $15,000, but only for tax purposes. | |||||||||||||||||
Redemption of shares (back to holding company) | |||||||||||||||||
Amount received (#shares * redemped value) | 10000 | ||||||||||||||||
PUC | -8000 | ||||||||||||||||
Deemed Dividend 84(3) | 2000 | ||||||||||||||||
Disposition | |||||||||||||||||
POD | 10000 | ||||||||||||||||
less deemed div | -2000 | ||||||||||||||||
Revised POD | 8000 | ||||||||||||||||
ACB of shares | -7500 | ||||||||||||||||
Capital Gain | 500 | ||||||||||||||||