Sell or Redeem Shares in a CCPC

by Tax Guy - Burlington Accountant on September 1, 2010 Print This Post Print This Post

If you worked for a small Canadian controlled private corporation (CCPC) and were offered shares in that corporation there may be tax consequences if the shares are redeemed by the corporation.

Small corporations, like large corporations, will often allow key employees to purchase shares of the corporation to allow key employees to share in the profits of the company.  As profits are earned, they are distributed to all shareholders based on their shareholdings. These distributionsare normally taxes as dividends in the shareholders hands.

Sales Of Shares Are Often Restricted

The stocks of small corporations cannot be sold on stock exchanges and shareholders agreements often restrict to whom the shares may be sold to (normally other existing shareholders).  As a result, if funds are required by the shareholder or if the shareholder terminates employment with the corporation, and qualified buyer is not available, then the corporation may redeem the shares at a specified price.

On the face of it sounds like you are saved if you can’t find a qualified buyer.  But the tax treatment of a share-redemption may be very different than a sale of shares to another person.

Situation

John was an employee of Investco Ltd. and was invited to purchase shares in the corporation as a reward for good service.  The shareholders agreement  restricts the re-sale of the shares issued to other qualified employees of Investco.  As an alternative, Investco will redeem the shares at their fair market value using a prescribed valuation formula.

John purchased 1,500 shares in 2004 for $100 each.  The paid up capital (PUC) of these shares was also $10 each.

In 2008, John left the corporation and the fair market value of the shares had grown to $400 each.  John’s marginal tax rate is 45% on normal income, 22.5% on capital gains, 33.33% on ineligible dividends and has never claimed any capital gains or losses in the past.

At the time, Investco was a CCPC and a qualified small business corporation. The company does not have a GRIP balance and therefore all dividends would be considered ineligible.

Scenario A – Sale of Shares to a Third Party

If a qualified shareholder was available to purchase the shares, and assuming that shareholder is not related to John and Investco, the tax consequences of the sale are as follows:

John will realize a capital gain of 1,500 shares x ($400- $100) = $450,000.  Since Investco is a qualified small business corporation and the capital gain is less than the $750,000 lifetime capital gains exemption, there are no tax consequences.

Scenario B – Investco Redeems The Shares for $400 Each

If John cannot find a buyer and Investco redeems the shares, then the Income Tax Act looks at the transaction differently:

  • The redemption at $400 per share results in a deemed dividend of 1,500 x ($400 – $10) = $585,000.  The marginal tax on the ineligible dividend would be $195,000.
  • The redemption also results in taxable capital loss of $67,500 that may qualify is an allowable business investment loss (ABIL) and could be deductible against other income.  If the loss were an ABIL, the tax savings realized would be $30,375.*
  • The total tax, assuming the ABIL may be fully claimed would be $164,625.

* The taxable capital loss is the proceeds of the redemption at $600,000 less the deemed dividend of $585,000, less the shareholders adjusted cost base of $150,000 times 50%.

Clearly an arms-length sale of the share shares is a better result as it would avoid the deemed dividend.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

Print This Post Print This Post

{ 41 comments }

Hazy September 1, 2010 at 9:15 pm

What happens if shares are bought and sold though a Trust which was
setup by the corp.?
Could the Trust act as a qualified shareholder?

Tax Guy September 3, 2010 at 8:46 am

Hazy,
I suppose, but where woukd the trust get the funds?

Tax Guy September 3, 2010 at 8:46 am

Hazy,
I suppose, but where would the trust get the funds?

Hazy September 3, 2010 at 8:12 pm

Could the Trust not borrow money from a bank?
Loan payments would be made with a dividend payed out on the shares purchased.

northgirl61 September 14, 2010 at 8:30 am

Does the the amount of shares certificate above have to be in the dollar value of the shares sold back to the company? Is this considered a legal receipt by revenue canada?

Tax Guy September 14, 2010 at 3:32 pm

@Northgirl61
I’m not entirely sure what you are asking. If the company redeems the shares they are taking the shares back and giving the shareholder money for them. It’s a tax event for the the shareholder.

northgirl61 September 14, 2010 at 5:47 pm

Example: Married couple A + B each own 50% in Class A shares of a company. A + B disolve the partnership. Equity is $100,000.00. But the debt is just over $100,000.00. B agrees to sell his shares to A for $50.00 as the debt wipes out his share of the equity….
However at the end of the year A puts through approx $50,000.00 as a bonus to A for the division of personal assets not related to the company. A t4 is issued and min tax taked off so CRA wants it’s share. B is disputing the T4.
A claims it was for B’s share of the company but the transfer of shares documentation show that those shares were sold to A for $50.00.
Question: Does the transfer of shares doc and certificate act as a receipt for CRA to prove that the $50,000.00 was not for B’s equity in the company??

Tax Guy September 17, 2010 at 6:57 am

First of all, the value of the shares for the purposes of any transaction for tax purposes will be deemed to be fair market value (FMV). This amount is generally considered to be an amount that an arms length person would pay for the shares. If the transaction occurred at any value other than FMV, the CRA will reassess the transactions at FMV.

In terms of valuation, I would question whether B’s shares were worth $50. Although you indicate debt = equity (I suspect you mean assets = debt because equity = assets – liabilities), A was able to pay a $50,000 bonus which would lead any reasonable person to believe that the company has intrinsic value since it was able to pay a bonus!

The corporation and the shareholders are separate and distinct entities and the fact that the corporation paid a bonus to a shareholder is not really relevant to the overall outcome. Although possible unfair from a divorce standpoint, I would argue that the “sale” of shares should have occurred at FMV.

In terms of the documentation, the CRA will certainly consider it but as I said the transaction must have occurred at FMV and if nit the CRA has the authority to deem the transaction to have occurred at FMV. Also, there is a provision in the income tax act that will unwind any transactions that were not within the spirit of the act (known as the general anti-avoidance rules).

If these were actual transactions, I would suggest strongly that you hire a very good corporate accountant to review the situation and handle the dispute with the CRA. I think these taxpayers have made some seriously costly errors that could have been avoided by engaging a professional at the start.

Ray October 18, 2010 at 12:00 pm

Hello Tax Guy,
What if the intent was to sell shares of the CCPC for an amount significantly less than FMV, to an arm’s length key employee as part of the founder’s succession plan.

Is the difference treated as an income inclusion for the employee? a deemed dividend, or capital gain? a gift? Are their any implications for the founder? Any implications if the CCPC is a farm?

Tax Guy October 19, 2010 at 10:07 am

The excess above fair market value would be a taxable benefit.

Ray October 19, 2010 at 11:01 am

Thanks Tax Guy, could you comment on a possible Scenario C: Assume John acquires shares via option agreement equal to 49% of the value of the company, he remains with the company & founder wants John to succeed him, can he exchange the shares (after 2 years) acquired via option agreement for the founder’s common shares? If so what are tax consequences for the founder and for John?

Tax Guy October 19, 2010 at 12:41 pm

Ray,
The option to buy would give rise to a taxable benefit if the exercise amount is less than the fair market value. The exercise of which would realize the benefit but it may be deferred. See the link in my last comment.

For the original owner: Its a deemed dividend if the company redeems the shares and its a capital agin if he sells them to John.

I would suggest that you hire an accountant to arrange this as corporate taxation has far too many variables that can go wrong.

Tom November 18, 2010 at 10:07 am

What practical method (aside from a formal valuation) of determining a FMV of a CCPC would you suggest if there are no arms length persons interested in buying shares of the CCPC.

Tax Guy November 20, 2010 at 3:07 pm

You can hire a CBV, ask your accountant or contact a real estate agent (real estate agents have access to business brokers).

Todd November 25, 2010 at 9:22 pm

Hi Tax Guy:
One of my friend own a consulting company (CCPC) over 2 years. The company has very little capital assets and the major part of the assets is cash of $100,000. A third party wants to buy this company through share exchange plus non-share consideration that worth $300,000 and $200,000 is goodwill (his brain). The condition is that my friend has to work for this third party for a number of years. My question is: Can my freind get capital gain exemption even with this amount of cash as the asset? Can he get non-share consideration without tax consequency? Thanks!

Tax Guy November 27, 2010 at 10:34 am

Todd,
Probably not. The requirement is that at the time of sale 90% of the assets be employed in an active business in Canada and in the 2 years prior to the sale, that 50% or more than the assets be employed in an active business in Canada.

Bill W. March 10, 2011 at 11:19 am

I have an incorporated family trust. At the time I owed $14k in personal taxes. I did a 85.1 transfer of debt obligations to the trust but I am still paying on the debt obligations. On my 2010 personal taxes I claimed an ABIL of $328k to reduce my personal taxes to 0 would this be correct.
Also how do I transfer my income to the trust, would this allow my personal income to be 0 as I am loaning all my income to it? Then claim trustees fees for administrating the trust as all the fees are returnable correct?

Tax Guy March 10, 2011 at 12:15 pm

A trust and a corporation are separate things. A trust is not a corporation nor can it be incorporated. Also 85.1 deals with share-for-share exchanges not rollovers. ABIL may be claimed if the funds were lent to the corp.

The nature of your “question” and complexity of the transitions suggest that you should be working with a trained tax professional. I cannot comment any further except to say that you should expecting a CRA audit in the

Bill W March 10, 2011 at 7:43 pm

By the way the CRA sent the forms for the incorporated trust, they wanted to make sure that it was a private trust, look at Bill C20 Canadian Ownership and Control; Act and I have a private auditor as well.

I was asking about the ABIL and capitol gains deduction for my self?

Tax Guy March 10, 2011 at 10:43 pm

Bill,
I looked at that Act and in Canada a corporation can only be established under provincial incorporation laws or the Federal CBCA.

A trust is not a corporation. A corporation is a legal entity established under law. A trust is a contractual relationship between three parties concerning an object.

If you have moved property to a trust, there is no ABIL. The ITA requires a corporation.

Vander March 10, 2011 at 3:01 pm

I don’t get the math – you say the Capital loss equals Proceeds of $600k less Deemed dividend of $585k less cost base of $15k. That equals zero. How do you get a $67,500 capital loss?

Tax Guy March 10, 2011 at 5:03 pm

The PoD is $600,000, the deemed dividend is $585,000 and ACB is $150,000 (100 x what the purchase price was, $100).

$600k – $585k – $150k = $135k. Half of that is $67,500.

SAM July 15, 2012 at 6:53 pm

My family (wife and kids) and I opened a business about four years ago, at that time I was worry that if I made any bad investment we could loose everything we had and for that reason I own 100% of the shares. Now days the company is a little more stable and I want my wife and kids own shares on the company, since they have been working with me, building the company to what it si now. My question is can they buy shares in the way that we all have equal number of shares for a dollar?

Tax Guy July 17, 2012 at 4:42 pm

Sam,

You have to be very careful. Adding your spouse may trigger attribution unless the corporation is a qualified small business corporation.

Adding the kids, if they are under 18, can be expensive because of the so-called kiddie tax and likely should be avoided.

If you want me to review your tax plan, contact me directly and we can talk about how I can help you reduce your tax bill.

Deveena Pittman July 18, 2012 at 10:45 pm

A friend of mine just quits his job. He has a 10% share in the company and now he wants his money back. What are the tax consequences in calgary, Alberta?

Deveena Pittman July 19, 2012 at 12:46 am

I was reading the Investco example. I got my answer. very helpful indeed. Thanks.

Tax Guy July 19, 2012 at 9:46 am

Glad the example helped. But, unless there is a contractual provision to redeem the shares, the company has no obligation to redeem.

Bear July 27, 2012 at 6:28 pm

Please explain to me the basic tax situation. Ltd. co. with 2 share holders that hold 50% each. The one partner just wants out with nothing in return. Company redeems shares verses other partner buying the 50% for a dollar.
If you need more information, please ask.

Burlington Accountant July 29, 2012 at 10:11 pm

The shareholders are not at arms-length with the corporation and 69(1) may apply to have the transaction deemed to occur at fair market value which could
trigger a deemed dividend under 84(3).

This assumes there were no provisions setting the pricing at the time the shares were issued or purchased.

You may want to contact me to set a plan.

Burlington Accountant July 29, 2012 at 10:13 pm

Assuming he lives in Canada, always has and have not contributed to a TFSA before, then he can invest $20k in the TFSA.

Tracy September 29, 2012 at 12:21 pm

Hello Tax Guy

I understand a small amount of my own scenario and was hoping you could help set me straight on the rest.

My husband bought 100,000 dollars (or 5%) of shares in the small company he works for. We took out a business loan of 80,000 to do this. We have paid capital gains on any income realized with the shares.

Now…my question is this…If we were to sell the shares back to the company would we be paying tax on the money owed to us even if the FMV had not changed making the shares worth the same amount at original purchase? We did not pay anything to the loan except interest as this was all written off as a business expense at tax time so the loan of 80,000 is still owing to the bank. I am questioning our decision to enter into this agreement of purchase because if we have to pay tax on the exact amount we purchased it seems to me that it wasn’t a very smart purchase in the end because we would still owe the bank 80,000 and we would have tax to pay on the 80,000 rec’d from the sale of shares back to the company which would mean we have lost money in the end.
The situation in the contact states that the shares will be purchased back by the employer/owner of company. But it doesn’t specify regarding the scenario in which this would be the corporation paying this out or the owner (he is described a the majority shareholder).
There are only 3 shareholders within this set up. The owner holds 85% , another employee holds 10% and my husband holds 5%.
I hope i have supplied enough information for you. Thanks so much.

Tax Guy September 30, 2012 at 8:46 pm

Hi Tracy,

Capital gains are triggered when you sell shares of the company. Otherwise the income was likely dividends.

Unless you own fixed value preferred shares, it is unlikely the FMV has stayed the same. Whether the company redeems the shares or they are sold to another shareholder the tax is on the GAIN, not on the investment.

Remember the gain or loss is what you get less what you paid!

Geni January 21, 2013 at 6:54 pm

Me and my spouse both own 50% shares in a CCPC. The corporation is loosing. I would like to transfer my 50% of shares to my spouse at $1. What do i need to do for that please guide.

Can we just sign on a word doument that i sell my shares to him. what authorities do we need to inform of the change.

Lee February 4, 2013 at 9:01 pm

I have been reading your article on the sale of shares in a corporation and find that I am a little confused, so I thought I would ask a question. Friends started a corporation 5 years ago and have realized that they are no longer friends. One shareholder just wanted the other one out, so paid a price that satisfied the wants of his former partner. Does the amount received by the former partner qualify for the capital gain exemption? The friends are not related and the corporation is CCPC. Thank you for your input.

Burlington Accountant February 5, 2013 at 11:07 am

Lee,
The Capital Gains exemption may be claimed only if a few conditions were met. This article talks about it.

Karen February 25, 2013 at 3:58 pm

Have client who has recently seperated from wife. As part of divorce the wife wants no part of the business. What is the best way to dispose of the shares (sell back to co for $1, cancel shares, etc) that would have the least amount of tax consequences/

Tax Guy - Burlington Accountant February 25, 2013 at 8:20 pm

There are a number of possibilities.

1. Husband buys shares from wife at cost before the separation date and then negotiate for other assets as another deal. No tax before or after. Spousal rollover before separation = no-tax.

2. Husband buys shares after separation. Assuming shares are qualified small business corporation shares, she could claim the capital gains exemption.

In the above scenarios, the corporation does not provide the cash as it is a transaction between shareholders.

If there is no CGE for option 2, husband buys shares and wife takes a note payable. She could spread the gain over a series of years.

3. Corporation redeems shares all at once. Deemed dividend and some taxes. Corporation need to have the cash or assets to settle the redemption.

As an alternative, the shares could be redeemed over time.

brad April 11, 2013 at 11:14 am

I’m not sure you can help, but if I work for a CCPC and went through a share redemption in 2012 in Quebec, my understanding is that that is federally taxed after a 50% deduction, but provincially after only a 25% deduction. Do you know if that’s true?

The background is that I was granted shares at a particular price, and last year those shares were bought back by the company for a profit. Should that money be reported as a capital gain or as an employment benefit?

Thanks!

Tax Guy - Burlington Accountant April 12, 2013 at 9:55 am

Brad,

The 50% would be the inclusion rate for capital gains (I’m not shure where the 25% for Quebec came from). However, when a corporation redeems or buys its shares back, the payment is considered a dividend and the tax treatment can be different.

Gaetan February 22, 2014 at 6:25 pm

Hi, have a similar situation. I paid shares $20 back in 2011 to my private company (I am en employee of a private Canadian company (which does not qualify for small business) per share for 100 shares ($20 x 1000 = $20,000). My understanding is that the $20 is also equal to the PUC at the time (contrary to your example above where $100 is different than $10), at least all I know is I paid $20 per share. In 2012 and 2013 I received a return of capital of $4 in each year. I left the company at the end of 2013 and so my shares were redeemed by the company at $15 (company value actually went down over 2 years).

My company just sent me a 2013 T5 for deemed dividend for $3 per share ( redeem price less PUC: $15 – ($20 – $8) ), I am leaving out the gross up of dividend for the taxable portion and credit since this is not the point of my question.

So I understand that I have to report this $3 dividend (I have a T5 for it) but do I need to enter anything in my tax return for capital gain/loss taking into account any ACB? Is my ACB still $20 and I should claim a capital loss of $5 ($15 – $20 = -$5)?

PUC and ACB here are confusing me…

Thanks in advance for any help!

Gaetan

Tax Guy - Burlington Accountant February 22, 2014 at 8:59 pm

PUC and ACB are different. ACB is what you paid for the shares while PUC is the legal stated capital of the company.

A return of capital will reduce your ACB.

Comments on this entry are closed.

Previous post:

Next post: