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.
Related Articles
- Capital Gains Exemption on Foreign Investment
- Canadian-controlled private corporation (CCPC)
- Selling Your Business & Saving Taxes
- Reader Mail Bag Update: Lifetime Capital Gains Exemption
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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!
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.
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?
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
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?
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.
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?
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.
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