Key Tax Attributes in Canadian Corporate Taxation

Course Overview

This study guide introduces foundational tax attributes relevant to Canadian corporate taxation, focusing on Adjusted Cost Base (ACB), Paid-Up Capital (PUC), Fair Market Value (FMV), and the concept of Deemed Dividends. Understanding these terms is essential for analyzing tax consequences of corporate transactions and shareholder activities.

ACB, PUC, and FMV: Introduction

Overview of Key Terms

• Adjusted Cost Base (ACB): The tax cost of a property, adjusted for certain additions and deductions as specified in the Income Tax Act (ITA).

• Paid-Up Capital (PUC): The amount of capital contributed to a corporation for shares, calculated at the corporate level and averaged across all shares of a class.

• Fair Market Value (FMV): The price that would be agreed upon in an open market between informed, arm's length parties.

It is important to distinguish whether these attributes are calculated at the shareholder or company level, as this affects tax outcomes.

Adjusted Cost Base (ACB)

Definition and Legislative References

• ACB is defined in Section 54 of the ITA for the purposes of taxable capital gains.

• Section 248(1) extends the Section 54 definition throughout the Act.

• ACB is used to calculate capital gains or losses on the disposition of capital property.

General Calculation of ACB

• ACB is generally the cost of the property, with adjustments:

  • Section 53(1): Adjustments added to ACB (e.g., additional investments, certain expenses).

  • Section 53(2): Adjustments deducted from ACB (e.g., returns of capital).

• For non-depreciable capital property, the starting point is the amount paid to acquire the asset.

• Special rules apply for shares acquired via stock dividends (Section 52(3)(a)).

Depreciable Capital Property and ACB

• Depreciable capital property is treated differently due to the Capital Cost Allowance (CCA) system.

• ACB for depreciables is restricted to the capital cost to the taxpayer (see Section 54(a)).

• No Section 52 or 53 adjustments for depreciables, to preserve the integrity of the CCA system.

ACB Cannot Be Negative

• Section 54(d) stipulates that ACB can never be less than nil.

• Relevant for interactions with Section 40(3) and Section 53(1)(a).

ACB of Shares

• Calculated at the shareholder level.

• Based on the amount paid for the shares.

• Unique to each shareholder, reflecting their individual shareholdings.

• Subject to adjustments under Section 53(1) and 53(2).

Paid-Up Capital (PUC)

Definition and Tax Planning Implications

• PUC is the capital contributed to a corporation for shares, calculated at the corporate level and averaged across all shares of a class.

• PUC can generally be returned to shareholders without tax consequences, making it a useful tool in tax planning.

• Numerous ITA provisions prevent artificial creation of PUC (e.g., Section 85(2.1)).

• Tax traps and planning opportunities arise because a shareholder's PUC is often not the same as their ACB.

• No ordering provision on distributions, so PUC can be returned before a taxable dividend (with restrictions for public companies under Section 84(4.1)).

• PUC is unique to the Canadian tax system.

Calculation of PUC

• PUC is defined in Subsection 89(1) of the ITA.

• Calculation steps:

  1. Begin with legal stated capital (per corporate statutes).

  2. Make adjustments as described in the definition (e.g., Subpara (b) of Section 89(1)).

  3. PUC of a class of shares is averaged across all shares in that class.

  4. The sum of PUC across all classes determines the corporation's total PUC.

• Do not assume financial statement capital equals tax PUC.

Example: PUC Calculation

Additional info: PUC per share is calculated by dividing total capital paid for all shares by total shares outstanding. Changes in share subscriptions or returns of PUC can affect PUC per share.

PUC Changes and Share Transactions

• PUC of a class can change if new shares are issued or PUC is returned to shareholders.

• To avoid a "PUC shift," consider issuing a separate class of shares for new subscribers.

• PUC is calculated at the corporate level and averaged among shareholders of a class.

PUC vs. ACB

• ACB is unique to each shareholder and reflects the amount paid for shares.

• PUC is calculated at the corporate level and averaged across all shares of a class.

• Each shareholder is assigned a PUC amount for their shares, but this may not match their ACB.

Fair Market Value (FMV)

Definition and Application

• FMV is referenced frequently in the ITA but is not generally defined in Section 248.

• FMV of a company is based on the value of its assets and business, less liabilities.

• FMV of shares depends on characteristics such as voting rights, dividend entitlement, redemption/retraction value, and dissolution rights.

• CRA's Policy Statement IC-89-3 defines FMV as the highest price obtainable in an open market between informed, arm's length parties, with no compulsion to transact.

FMV in Practice

• Professional valuators (e.g., Chartered Business Valuators) may be required to determine FMV.

• FMV is critical in non-arm's length transactions, where parties may not transact at true market value.

• In tax problems, FMV is often provided as a fact unless otherwise indicated.

Example: FMV Determination

• Transferring a public share portfolio to a corporation: FMV is determined by market prices.

• Transferring private company shares or real estate: FMV may require professional valuation and consideration of asset characteristics.

Deemed Dividends (Intro)

Definition and Legislative Triggers

• Deemed dividends are amounts treated as dividends for tax purposes, even if not formally declared.

• Section 84(1): Triggers a deemed dividend when PUC is artificially increased by a company.

• Exceptions include stock dividends, PUC shifts between classes with no net increase, and capitalization of contributed surplus.

• Deemed dividends per Section 84(1) are added to the ACB of shares to prevent double taxation on subsequent sale.

Deemed Dividend on PUC Reduction

• Section 84(4): Triggers a deemed dividend when a company reduces PUC and pays out more than the recorded PUC reduction.

• Shareholders receive a proportionate amount of the deemed dividend based on their shareholdings.

• The PUC reduction (except for the deemed dividend portion) reduces the shareholder's ACB.

Summary Table: Deemed Dividend Triggers

Key Formulas and Equations

Capital Gain Calculation

• Capital gain or loss on disposition of capital property:

PUC per Share Calculation

• PUC per share for a class:

Conclusion

Understanding ACB, PUC, FMV, and deemed dividends is essential for analyzing the tax consequences of corporate transactions in Canada. These attributes affect both the calculation of taxable income and the planning opportunities available to corporations and shareholders.