CHAPTER 8 TOBIAS TAXATION OF CORPORATE DISTRIBUTIONS

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CHAPTER 8 TOBIAS TAXATION OF CORPORATE DISTRIBUTIONS

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Title: CHAPTER 8 TOBIAS TAXATION OF CORPORATE DISTRIBUTIONS

1
CHAPTER 8 TOBIASTAXATION OF CORPORATE
DISTRIBUTIONS

FRANK LAVITT

Mike Luzny previously dealt with the topics of
Section 15 and paid up capital
Today's lecture will not deal with Section 15.
However it will briefly review paid up capital.

Profitable corporations may deal with cash in a
variety of ways
They may either pay out such profits or choose to
reinvest the cash in the operations of the
corporation.
When the corporation distributes after tax
profits to its shareholder, either in cash or in
kind the shareholder is said to have received a
dividend.

A dividend in kind is one paid by something other
than cash.
The term dividend is not defined in the Act other
than at sub-section 248(1) which provides that it
includes a stock dividend.

Both CRA and the Courts have agreed that any
distribution of income that is divided pro-rata
among shareholders may properly be described as a
dividend unless the corporation can show that it
is another type of payment (CRA, Interpretation
Bulletin IT - 67R3).

There are at least four types of distributions
that certain Payors label as "dividends" but that
are not considered dividends under the Act.
These are
dividends on a savings or similar account at a
Credit Union (considered interest)
dividends on participating life insurance policy
(considered a refund of overpayment of premiums)

patronage dividends distributed by a Co-operative
(either non-taxable, taxable as other income or
reduces capital cost of assets) and
capital gains dividends distributed by a mutual
fund (considered capital gain income).

Taxpayers are required by paragraphs 12 (1)(j)
and (k) to include dividends from both resident
corporations and non-resident corporations in
income.
subsection 82(1) of the Act requires that all
taxable dividends received from a corporation
resident in Canada be included in the calculation
of income.
a "taxable dividend" is defined at subsection
89(1) as one other than a capital dividend.

subsection 90(1) of the Act requires that all
dividends received from a non-resident
corporation be included in the calculation of
income.
In summary, all dividends (except those mentioned
above, which are not really "dividends") are
income.

Dividends other than capital dividends from
resident corporations are labeled taxable
dividends. Dividends from non-resident
corporations are just labeled dividends.

There are special rules as to how dividends are
included in income.
Do not make a mistake of thinking taxable
dividend means "as opposed to a non-taxable
dividend".
To repeat a taxable dividend is simply a dividend
from a resident corporation (other than a capital
dividend).

There are a number of provisions in the Act that
address and include in income the withdrawal of
money or realization of other benefits by
shareholders from corporations.
These amounts are often characterized as deemed
dividends.
The Act will direct whether or not the deemed
dividend is a taxable dividend or not.

Although most dividends are usually paid in the
form of cash, corporations can (and sometimes do)
pay a non-cash dividend or a dividend in kind.

The cash equivalent (fair market value) of the
asset received is the amount of the dividend for
tax purposes.

Consequently a dividend in kind is no different
than a cash dividend.

How a dividend is taxed as income to the
recipient depends on whether the recipient is an
individual (including a partnership and a trust)
or a corporation, whether the dividend is from a
resident or a non-resident corporation, whether
it is a stock dividend or not and whether or not
it is an income amount that it is just being
deemed a dividend.

17
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18

DIVIDENDS AND INDIVIDUALS
Dividends Received from Corporations Resident in
Canada
Dividends received by individual Canadian
residents (including trusts and partnerships)
from corporations resident in Canada are labelled
taxable dividends are included in income by
paragraph 12(1)(j) in accordance with the 25
"gross-up" provision found at subsection 82(1).

The gross-up rule is that the amount of the
dividend that is taxable (i.e. included in
income) is 125 of the actual dividend.
For example, if an individual receives a 200
taxable dividend, the taxable amount of the
dividend is 250 per paragraph 82(1)(b).

In aggregating the net income from property, 250
represents the taxable amount to be reported in
paragraph 3(a) of the Act accumulation of net
income.
Paragraph 3(a) Income from Property
Taxable dividend received 200
Dividend gross-up 50
Taxable amount of dividend 250

While including an extra 25 in income appears
unfair, it is offset by a tax credit (called the
dividend tax credit) which the taxpayer is
entitled to claim when calculating their actual
income tax.
The inner-workings of the gross-up and the
dividend tax credit are a recognition that the
dividend has been paid from after-tax corporate
earnings. A simple inclusion of a dividend in
income would result in double taxation.

Therefore the extra 25 of the taxable dividend
(the "gross-up") included in an individuals
income under paragraph 82(1)(b) is conceptually
offset by a credit in computing Part I tax (the
dividend tax credit) equal to 2/3 of the gross-up
(under section 121).

Thus a 100 taxable dividend received by an
individual gives rise to an income inclusion of
125 (section 82) but earns a credit of 16.66
against Part 1 tax.
16.66 is 2/3 of 25.

In accordance with changes in the 2006 Federal
Budget, the dividend gross-up is increased to 45
and the dividend tax credit is 11/18 of the
gross-up (approximately 19 of the grossed-up
amount) for taxable dividends paid after 2005
(called "eligible dividends") by
i) public corporations resident in Canada and
subject to the general income tax rate and

ii) CCPCs resident in Canada to the extent that
their income, other than investment income, is
subject to tax at the general corporate tax rate
(in essence dividends paid out of active business
income that is not eligible for the small
business deduction).

Thus,
dividends subject to the 25 gross-up
(82(1)(b)(i)) (also colloquially known as
ineligible dividends) include
dividends from the active business income of
Canadian Controlled Private Corporations that are
eligible for the small business deduction
dividends from investment income.

dividends eligible for the 45 gross-up
(82(1)(b)(ii)) (legally defined as "eligible
dividends"), include
dividends from the active business income of
CCPCs that are not eligible for the small
business deduction
dividends from Canadian public companies and
other corporations that are not CCPCs (resident
in Canada), and subject to the general corporate
tax rate.

The gross-up and dividend tax credit are part of
a unique Canadian taxation concept known as
"integration".
Integration is an attempt by the tax system to
recognize that 1 of income earned through a
corporation and then distributed to a shareholder
should not bear any more tax than 1 of income
earned directly by a shareholder.

There are four "tools" in the Act directed
towards integration
the gross-up mechanism
the dividend tax credit
the capital dividend account and
the Refundable Dividend Tax On Hand account.

The gross-up and credit system recognizes that
individual shareholders receiving dividends from
taxable Canadian corporations pay personal tax on
dividends received in addition to the underlying
corporate tax already paid on earnings from which
the dividend is paid.
Therefore the gross-up is theoretically intended
to restate the dividend in a form that represents
corporate pre-tax earnings.

The dividend tax credit reduces federal and
provincial taxes by an amount that theoretically
represents the tax paid by the corporation.
Tax neutrality is achieved where the total of
corporate tax on the earnings and shareholder
level tax on the distribution of such earnings
approximates the personal tax to which the income
would have been subject had it been earned
directly.

ELIGIBLE DIVIDEND
For income subject to tax at full corporate rates
(including personal services business income) tax
neutrality is not achieved with the 25 gross-up
and 2/3 dividend tax credit system.

The 45 gross-up that was introduced in the 2006
budget and dividend tax credit equal to 11/18 of
the gross-up comes significantly closer to
achieving tax neutrality on dividends paid out of
active business income of Canadian Control
Private Corporations that is not eligible for the
small business deduction and on dividends from
Canadian public companies and other corporations
that are not CCPCs (resident in Canada) and
subject to the general corporate tax rate.

An individual shareholder resident in Canada
receiving an eligible dividend is entitled to a
45 gross-up (as opposed to a 25 gross-up for
other taxable dividends) and a federal dividend
tax credit equal to 11/18 of the gross-up (as
opposed to 2/3).
An eligible dividend is a taxable dividend
received by a person resident in Canada paid
after 2005 by a corporation resident in Canada
and designated as such by the corporation
(eligible dividend is defined in subsection
89(1)).

A corporation designates a dividend as an
eligible dividend by notifying, in writing, each
person to whom any part of the dividend is paid
that the dividend is an eligible dividend (see
subsection 89(14)).

Lets skip ahead to the Appendix of Chapter 8 of
Tobias.
The Appendix of Chapter 8 of Tobias gives a good
general summary of eligible dividends.
The eligible dividend rules introduced in the
2006 budget builds upon but does not replace the
existing gross-up and dividend tax credit
provisions.

From the stand point of the individual taxpayer,
eligible dividend benefits from a 45 gross-up
(as opposed to a 25 gross-up for other taxable
dividends from taxable Canadian corporations) and
a federal tax credit equal to 11/18 of the
gross-up.
A dividend is an eligible dividend if the
dividend paying corporation has given the
dividend recipient notice to that effect
(subsection 89(14)).
The recipient can rely on that notice and need
not know anything about the tax status of the
corporation.

For the dividend paying corporation, an eligible
dividend is any dividend the corporation
designates to be one.
Some corporations will have a limited capacity to
pay eligible dividends.
If their designations exceed that capacity they
are liable to a special tax.
That special tax applies to the excess amount or
if the corporation can reasonably be considered
to have attempted artificially to increase its
capacity to pay eligible dividends, to the full
amount of the alleged "eligible dividend".

The capacity of a corporation to pay eligible
dividends depends mostly on their status.
If a corporation is a Canadian controlled private
corporation or a deposit insurance corporation,
they can pay eligible dividends only to the
extent of its general rate income pool ("GRIP")
(subsection 89(1)).
GRIP is a balance generally reflecting taxable
income that has not benefited from the section
125 small business deduction or any of certain
other special tax rates.

A corporation resident in Canada that is neither
a CCPC nor a deposit insurance corporation (a
"non-CCPC") can pay eligible dividends in any
amount unless it has a low rate income pool
("LRIP") (subsection 89(1)).
The LRIP is generally made up of taxable income
that benefited from the small business deduction
either in the hands of the dividend paying
non-CCPC itself (at a time when it was a CCPC) or
in the hands of a CCPC that paid an ineligible
dividend to a Non-CCPC.

Many Non-CCPCs will never have a LRIP and thus
will be able to designate all their dividends as
eligible dividends.
If a non-CCPC has a LRIP balance dividends must
be paid out of the LRIP balance before a non-CCPC
can pay an eligible dividend.

More precisely, if a non-CCPC designates a
dividend as an eligible dividend despite having
the LRIP it is liable to a special tax.
However the designated dividend remains an
eligible dividend as far as the recipient of the
dividends is concerned.

A non-CCPC can pay an eligible dividend to the
extent that it does not have a LRIP at the time
the dividend is paid.
The non-CCPC must exhaust its LRIP before it can
pay dividends out of its general rate income
pool.

A CCPC can pay eligible dividends at any time
provided the amount designated as eligible
dividends during the year does not exceed its
year end general rate income pool.

The GRIP definition is intended to capture at the
end of each taxation year after 2005 the
after-tax earnings of a CCPC that have been
subject to the general corporate rate based on a
notional combined federal-provincial corporate
rate of 32.

A change in the status of a corporation to or
from CCPC status and the amalgamation or winding
up of corporations may result in a GRIP or LRIP
account for a corporation that previously did not
have an account or an increase in the balance of
a pre-existing account.
All corporations, but particularly public
(non-CCPC) corporations, must now add elements of
due diligence to determine whether and to what
extent an acquisition, reorganization or even an
inter-corporate dividend will decrease GRIP or
increase LRIP and limit its ability to pay
eligible dividends to the shareholders.

If a non-CCPC designates a dividend as an
eligible dividend at a point in time when it has
a LRIP balance, it will have made an excessive
eligible dividend designation to the extent of
the LRIP balance (subsection 89(1)).

Similarly, if a CCPC designates dividends as
eligible dividends in excess of its year end GRIP
balance, it will have made an excessive eligible
dividend designation to the extent of the excess.

If a corporation makes an "excessive eligible
dividend designation", it will be liable to pay a
tax under new Part III.1.
The tax is generally 20 of the excess amount.
A dividend that results in an "excessive eligible
dividend designation" retains its designation as
an eligible dividend from the shareholders' point
of view, except where a prescribed election is
filed to treat an eligible dividend otherwise
subject to Part III.1 tax to be a separate
dividend.

Every corporation resident in Canada that pays a
taxable dividend (other than a capital gains
dividend) in a taxation year must file a return
under Part III.1.
The return must include an estimate of the
corporation's Part III.1 tax payable and is due
on the corporation's filing due date.

The shareholder tax in respect of a CCPC's
aggregate investment income and portfolio
dividends is effectively prepaid in the form of
the refundable portion of the Part I tax or the
Part IV tax.
Therefore, there is little opportunity to defer
the shareholder tax by earning investment income
through a corporation.
However, in the case of active business income of
a CCPC, the shareholder tax is deferred as long
as the distribution of after-tax income is
postponed.

DIVIDENDS IN KIND
Dividends need not be paid in cash.
A corporation can make a distribution in kind
consisting of its assets.
Where a corporation has paid a dividend in kind,
the corporation is deemed to have disposed of the
property for proceeds equal to fair market value
and the shareholder is deemed to have acquired
the property at a cost equal to this fair market
value (subsection 52(2)).

The tax consequences of a payment of a dividend
in kind are equivalent to those on a sale of
corporate asset followed by a distribution of the
proceeds as a dividend.

STOCK DIVIDENDS
The definition of "stock dividend" must be read
together with the definition of "amount", both
terms being defined in subsection 248(1).
A "stock dividend" means any dividend (determined
without reference to the definition of "dividend"
in subsection 248(1)) paid by issuing shares of
any class of the capital stock of a corporation.

The amount of any stock dividend is most
frequently the amount by which the "paid-up
capital" of the corporation paying the dividend
is increased by reason of the payment of the
dividend (definition of "amount" in subsection
248(1)).

The cost to a shareholder of a stock dividend is
(subsection 52(3))
where the stock dividend is a dividend, the
"amount" of the stock dividend
where the stock dividend is not a dividend, nil
and
where an amount is included in the shareholder's
income in respect of the stock dividend under
subsection 15(1.1), the amount so included.

When is a stock dividend not a "dividend"?
The answer is to be found in the definition of
"dividend" in subsection 248(1) where "dividend"
is defined to include a stock dividend, other
than a stock dividend from a non-resident
corporation that is paid to a corporation or to a
mutual fund trust.

Subsection 15(1.1) applies to include in a
shareholder's income the fair market value and
not the paid-up capital increase in respect of a
stock dividend when it may reasonably be
considered that one of the purposes of paying the
stock dividend was to significantly alter the
value of the interest of a specified shareholder
(subsection 248(1)) of the corporation.
(Specified shareholder is someone that owns not
less that 10 of the shares of any class).

The determination of whether one of the purposes
of paying the stock dividend was to significantly
alter the value of the interest of a specified
shareholder must be objectively reasonable.

CAPITAL DIVIDEND ACCOUNT
One of the basic principles of the Act is to
achieve integration when the income earned by a
private corporation is subsequently paid to
shareholders who are individuals.
One of the integration tools that achieves this
is the capital dividend account.
Only a private corporation has a capital dividend
account.

A dividend that is paid from the corporation's
capital dividend account is non-taxable to the
Canadian resident shareholder.
Only a private corporation has a CDA.
Private corporations include non-Canadian
controlled Private Corporations as well as
Canadian controlled Private Corporations.

The capital dividend account allows private
corporations to distribute the non-taxable
portion of capital gains and other non-taxable
earnings, such as certain life insurance
proceeds, to shareholders as a tax-free dividend.
These amounts would not have been taxable if the
individual had personally realized the proceeds
of life insurance policies.
The intent of the capital dividend account is to
preserve the concepts of integration, ensuring
that the tax result to the shareholder is the
same as if the shareholder has earned or received
the income directly.

The capital dividend account is composed of
the non-taxable portion of capitals gains (50 of
the capital gain, or the appropriate percentage
from preceding years), net of the non-allowable
portion of capital losses
the non-taxable portion of proceeds of
dispositions of eligible capital property
life insurance proceeds and
capital dividends received from other
corporations.

Example
AAAB Co. Ltd. sold land for proceeds of 95,000,
and the adjusted cost base was 55,000. What, if
anything, is added to AAAB Co. Ltd.'s capital
dividend account?
Solution
Capital gain 40,000
Taxable capital gain 20,000
Non-taxable portion of capital gain 20,000
Addition to capital dividend account 20,000
The 20,000 may be paid by AAAB Co. Ltd. as a tax
free capital dividend to the shareholders.

Before a capital dividend may be paid, the
corporation must file Form T2054 with the
information required by REG 2101.
The required information includes a schedule
showing the computation of the Capital Gain
Account and a certified copy of the resolution
authorizing the capital dividend.
It is extremely important to ensure the capital
dividend account is calculated correctly, as
excessive capital dividend elections are subject
to a 60 tax (formerly a 75 tax).

The calculation of the capital dividend account
is made in accordance with the rules set out in
the definition of the capital dividend account in
subsection 89(1).
The wording of this definition is complex and
should be studied along with the following
comments, which simplify the paragraphs of the
definition of the capital dividend account in
subsection 89(1).

1. The period mentioned throughout the
definition of the capital dividend account is
defined in clause (a)(i)(A) of this definition as
follows
a) In the case of a corporation that has always
been a private corporation, the period that
starts on the first day of its first taxation
year ending after 1971, or its date of
incorporation if it was incorporated after 1971
and
ends at the time the calculation is made.

b) Where a corporation has not always been a
private corporation, the period that
starts with the first day of the first taxation
year immediately following the one in which it
became a private corporation and
ends at the time the calculation is made.

2. Paragraph (a) of the definition sets out the
calculation for the inclusion of the untaxed
portion of net capital gains realized during that
period.
3. Paragraph (b) provides for the inclusion of
capital dividends received by the corporation
from another private corporation.
4. Paragraph (c) determines how to calculate the
untaxed amount of the gain on the disposition of
eligible capital property (ECP) that must be
included in the capital dividend account. It is
the most difficult part of the definition of the
capital dividend account to understand.

5. Paragraph (d) provides for the inclusion of
life insurance proceeds in excess of the ACB of
the policy.
6. At the end of the definition, it is
stipulated that the capital dividend account is
reduced by any capital dividend paid by the
corporation.

Paragraph (f) of the definition of "capital
dividend account" provides for the increase in a
corporation's capital dividend account of an
amount in respect of the non-taxable portion of
capital gains distributed by a trust to the
corporation.
This amendment is necessary since subsection
104(21), where it applies, deems only the taxable
portion of a trust-level capital gain to be
realized by the beneficiary.

There appears to be no similar provision in the
Income Tax Act which serves to increase a
corporate partner's capital dividend account by
the partner's proportionate share of a capital
dividend received by the partnership.
However, it is administrative practice to allow a
corporate partner to include its share of a
capital dividend received by the partnership in
computing its capital dividend account at the
time the partner becomes entitled to receive a
share of that dividend under the terms of the
partnership agreement.

For example, if the partnership agreement
provides that a particular corporate partner is
entitled to a share of a capital dividend at the
time the dividend is received by the partnership,
CRA would allow that partner to include its share
of the dividend in its capital dividend account
at that time.
If the partnership provides that a capital
dividend received by the partnership is to be
shared by the members of the partnership at the
end of the partnership's fiscal period, a
particular corporate partner would only be
permitted to include its share of that dividend
in its capital dividend account at that time.

DEEMED DIVIDENDS
Overview
Returns of capital that are not dividends should
generally be capital receipts that may give rise
to capital gains that could be sheltered with net
capital losses from other years or a capital
gains exemption, depending upon the recipient's
tax profile.
The avoidance of the shareholder level tax on
corporate distributions that are structured as
capital receipts is known as "dividend (surplus)
stripping".

The intent of the deemed dividend rules is to
curb such surplus stripping by, in general terms,
deeming amounts distributed in excess of paid-up
capital in respect of the relevant shares to be a
dividend.
Deemed dividend rules are contained in
subsections (1) through (9) of section 84.
Their application is restricted to corporations
that are resident in Canada.

Broadly speaking, they apply to corporate
distributions that are not a distribution of
profits as a matter of corporate law.
Under these rules, a distribution is deemed to be
a dividend to the extent that the amount of the
distribution exceeds the paid-up capital in
respect of the subject shares.

Generally speaking, the paid-up capital in
respect of a class of shares can be returned
tax-free to shareholders as capital.
Distributions by corporations that are not
resident in Canada that are not dividends as a
matter of corporate law are generally on capital
receipts.
Subsection 84(4) deals with returns of capital on
a paid-up capital reduction.

Subsection 84(3) deals with returns of capital on
the purchase of shares for cancellation or on the
redemption of shares.
Subsection 84(2) deals with windings-up
distributions.

PAID-UP CAPITAL REDUCTIONS
Under most business corporation statutes, the
paid-up or stated capital in respect of class of
shares can be reduced provided that certain
financial capacity or solvency tests are not
contravened.
Since paid-up capital for income tax purposes
tracks paid-up or stated capital under the
relevant corporate law, decreases in paid-up or
stated capital under the relevant corporate law
will result in decreases in paid-up capital for
purposes of the Income Tax Act.

Pursuant to subsection 84(4), generally, where a
paid-up capital reduction in respect of a class
of shares is accompanied by a distribution to
shareholders, the excess of the amount
distributed over the paid-up capital reduction is
deemed to be a dividend.
There is no disposition of the shares where
amounts are distributed on a paid-up capital
reduction.

The amount paid to shareholders as a tax-free
return of capital reduces the adjusted cost base
to the shareholders of their shares (subparagraph
53(2)(a)(ii)).
If the return of capital exceeds the adjusted
cost base to the shareholder of the shares
otherwise determined, there is a deemed gain
equal to the amount of the excess (subsection
40(3)).

PURCHASE FOR CANCELLATION OR REDEMPTIONS OF
SHARES - SUBSECTION 84(3)
As a matter of corporate law, on the purchase for
cancellation or redemption of shares of a class,
there is a reduction in the stated capital in
respect of that class.
The reduction is proportionate to the percentage
of shares of that class purchased for
cancellation or redeemed.

Similarly, as a matter of corporate law, the
cancellation of shares of a corporation on its
winding-up results in a stated capital reduction
in respect of the shares.
In a non-winding-up context, where a corporation
resident in Canada has redeemed, acquired or
cancelled its shares, the redemption, acquisition
or cancellation is deemed to be a dividend on a
separate class of shares comprising the shares
redeemed, acquired or cancelled, to the extent
the amount paid exceeds the paid-up capital
(before giving effect to the reduction arising on
the redemption, acquisition or cancellation) in
respect of the subject shares (subsection 84(3)).

Shares that are purchased for cancellation or
redeemed are disposed of.
Accordingly, there is the potential for capital
gain or capital loss to be realized on the
disposition.

WINDING-UP DISTRIBUTIONS
The amount or value of funds or property of a
corporation distributed or otherwise
appropriated, in any manner whatever, to the
holders of any class of shares on the winding-up,
discontinuance or reorganization of its business,
is deemed to be a dividend to the extent the
amount or value exceeds the amount by which the
paid-up capital in respect of shares of that
class is reduced on the distribution or
appropriation.

The words "distributed or otherwise appropriated
in any manner whatever on the winding-up,
discontinuance or reorganization of its business"
are words of the widest import, and cover a large
variety of ways in which corporate funds can end
up in a shareholder's hands.
See Minister of National Revenue v. Merritt
Smythe v Minister of National Revenue (1969), 69
D.T.C. 5361 (S.C.C.).

As a matter of corporate law, the paid-up or
stated capital in respect of a class of shares is
reduced on a winding-up distribution to the
extent paid-up or stated capital is returned to
shareholders on the distribution.
Arguably, a cancellation (and therefore a
disposition) of shares of a corporation being
wound up occurs at the time the winding-up
entitlement attaching to such shares is satisfied
with a distribution.

This conceptual framework allows the disposition
of shares to coincide in time with the deemed
dividend under subsection 84(2), thus fitting
with the scheme of the Income Tax Act under which
capital may be returned tax-free to shareholders.
Consistent with this scheme, "proceeds of
disposition" excludes an amount deemed not to be
a dividend.

Thus, if shares of a corporation being wound up
are regarded as having been disposed of on the
winding up distribution, gain is measured as the
difference between proceeds of disposition (as
reduced by subsection 84(2) deemed dividend) and
the adjusted cost base of the shares disposed of.
Generally, if adjusted cost base reflects
invested capital, the paid-up capital of the
shares should be equivalent.

Thus, capital invested is returnable to
shareholders without tax consequences on the
winding-up of a corporation.
The proper tax result, as just described, does
not appear to be achievable if the disposition of
shares of a corporation being wound up is not
considered to occur coincident with the
subsection 84(2) deemed dividend.

Where property of a corporation has been
appropriated on the winding-up of the
corporation, the corporation is deemed to have
disposed of the property immediately before the
winding-up of proceeds equal to its fair market
value at that time and the shareholder is deemed
to have acquired the property at a cost equal to
its fair market value immediately before the
winding-up (subsection 69(5)).
The effect of subsection 69(5) is to place
windings-up without liquification of assets on
the same tax footing as windings-up with
liquification of assets.

DISPOSITIONS ON A PURCHASE REDEMPTION OR
CANCELLATION OF SHARES
"Proceeds of disposition" in section 54 excludes
any amount that would otherwise be proceeds of
disposition of a share to the extent that the
amount is deemed by subsection 84(2) or 84(3) to
be a dividend received and is not deemed not to
be a dividend.

Thus, where shares are disposed of (e.g. on their
purchase for cancellation, redemption or
cancellation on a winding-up), any capital gain
or capital loss arising is generally measured as
the amount received from the corporation less the
amount of any deemed dividend under section 84.

Example - Gain Realized on Redemption of Shares
Assume that the aggregate paid-up capital in
respect of preferred shares of a class is
100,000 and their aggregate redemption amount is
1,000,000.
Subject to the operation of certain specific
anti-avoidance rules, there would be a deemed
dividend of 900,000 on the redemption of the
shares (the amount by which proceeds of
1,000,000 exceeds the paid-up capital of
100,000 in respect of the shares immediately
before their redemption) (subsection 84(3)).

Since the redemption results in a disposition of
the shares, the gain or loss must be determined.
In measuring gain or loss, proceeds of
disposition is 100,000 being the amount received
(1,000,000) less the amount deemed to be a
dividend (900,000).
The proceeds of disposition must be compared to
the adjusted cost base of the shares disposed of
to determine gain or loss.

PAID-UP CAPITAL INCREASES
The purpose of subsection 84(1) is to prevent a
corporation from converting its retained earnings
into paid-up capital, as a preliminary step to
returning paid-up capital to shareholders tax
free.
Subsection 84(1) provides that every increase in
paid-up capital other than those enumerated
results in a deemed dividend.

A paid-up capital increase resulting from the
payment of a stock dividend (the "amount" of a
stock dividend, being the paid-up capital
increase which is taxable in the same way of any
other dividend) is excluded (paragraph 84(1)(a)).
Likewise, paid-up capital increases resulting
from the issuance of shares for fair market value
consideration equal to the paid-up capital
increase are excluded (paragraph 84(1)(b)).

The amount of a deemed dividend under subsection
84(1) increases the adjusted cost base to the
shareholder of the shares on which the deemed
dividend is received (paragraph 53(1)(b)).
In this regard, there is asymmetry between the
effects on the cost base of shares of a paid-up
capital increase and a paid-up capital reduction.

The cost base of shares is decreased by an amount
returned to shareholders on a paid-up capital
reduction, except to the extent the amount is
deemed to be a dividend by subsection 84(4)
(paragraph 53(2)(a)(ii)).
Paid-up capital returned to shareholders (that is
not deemed to be a dividend under subsection
84(4) reduces the adjusted cost base of shares
while paid-up capital increased (that are deemed
dividends under subsection 84(1)) increased the
adjusted cost base of shares.

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MISCELLANEOUS PROVISIONS IN SECTION 84
Subsection 84(4.1) provides that a payment on a
reduction of paid-up capital by a public
corporation will be treated as a dividend, except
where the payment is made by way of a redemption,
acquisition or cancellation of a share or in the
course of a transaction described in subsection
84(2), section 86 or, in general terms where the
amount paid on a reduction of paid-up capital may
reasonably be considered to be a distribution of

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proceeds of disposition realized from a
transaction that did not occur in the ordinary
course of the corporation's business and those
proceeds were derived from a transaction that
occurred no more than 24 months before the return
of the paid-up capital.

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