Deemed dividend

Why the law deems a dividend

A dividend is normally a return on a shareholder’s investment that the board declares. Some transactions move value from a corporation to a shareholder in a way that looks like a dividend, so the Income Tax Act treats the relevant amount as one. The label on your paperwork does not decide this. The substance of the transaction does.

The CRA describes four general situations. Paid-up capital goes up, other than through a stock dividend, without a matching rise in net assets or fall in net liabilities. Property is distributed to shareholders when a business is wound up, discontinued or reorganized. The corporation redeems, acquires or cancels its own shares, other than through an ordinary purchase on the open market. Or the paid-up capital of a class of shares is reduced.

How the amount is worked out

In general terms, the CRA says the deemed amount is the money or property received, less the paid-up capital that comes back with it. For a redemption, include the full amount paid and deduct the paid-up capital of the shares redeemed. For a wind-up distribution, include the full amount or value distributed and subtract any reduction in paid-up capital for that class. Paid-up capital is, roughly, what shareholders contributed for their shares.

The same logic applies to the other two situations, with the adjustments the CRA describes for increases in net assets and for changes in other share classes.

A simple illustration

Suppose a corporation buys back all of an owner’s shares for $100,000, and the paid-up capital of those shares is $100. The $99,900 difference is generally treated as a deemed dividend, and the $100 is not. The corporation does not pay a dividend in the ordinary sense, yet the shareholder is generally taxed as if it had. The figures are illustrative and ignore other tax rules that may apply to the sale of shares.

What a deemed dividend is not

The CRA’s shareholder benefits guidance treats a deemed dividend as separate from a shareholder benefit, which is the usual route for personal expenses a corporation pays for an owner. It also lists exceptions, such as a return of invested capital, so not every payment to a shareholder is a dividend. For shareholder loans, see the shareholder loan account entry.

What to discuss with your accountant

Raise any plan to redeem or cancel shares, wind up or reorganize a company, or change its share structure before it happens. Bring the share register, the records of what was paid for the shares, and any earlier reorganizations. Deemed dividends are reported on the T5 slip, and the corporation’s own designation and filing questions are separate. Ask who handles each step and how the result affects the owner’s personal return.