Introduction to corporate distributions and windups

1. Corporate distributions, windings-up and sales

2. Today’s topics The tax-free or tax-paid components of corporate surplus Tax effects of distributing corporate surplus How to analyze the two options of selling Applying the distribution of a variety of dividends Options available on the sale of a corporation

3. Corporate surplus balances Need to analyze the shareholders equity section of the balance sheet in order to create the tax-basis balance sheet

4. PUC of shares PUC is an important concept as it is the amount which the corporation can return to the shareholder without being reported as a dividend Otherwise known as the ACB PUC is aftertax funds of the shareholder

5. Terms Legal stated capital Paid-up capital Share capital Normally all equal Can be different on sec transfer

6. Effect of PUC Computed at corporate level and not shareholder level ACB is computed at shareholder level Can lead to deemed dividend when a portion of the shares are disposed of

7. background Joe incorporated Smithco 5 years ago and paid $1,000 for 1,000 common shares. His ACB is $1,000 and the PUC is $1,000 Joe needed additional capital and Bill bought 1,000 shares for $100,000. Joe’s ACB is $1,000 and Bill’s ACB is $100,000 PUC is $101,000 and is equally allocated PUC for Joe and Bill is $50,500 each

8. Illustration

9. Summary PUC Calculated at corporate level Based on capital contributed to the corporation Averaged among all shareholders of that class Can be withdrawn free of deemed dividend ACB Calculated at shareholder level Based on amount paid for the shares Unique to each shareholder Considered on disposition of shares

10. Capital dividend account Completes the integration of corporate and personal tax on capital gains and similar receipts Only in private corporations Starts from date of incorporation

11. The components Portion of net capital gains (gains in excess of losses) not recognized in computing income for tax plus Capital dividends from other corporations plus Portion of net gain not recognized in CEC plus Proceeds arising from death on life insurance minus Capital dividends paid

12. CEC CEC is normally at ¾ To include correct amount in capital gain, multiply by 2/3

13. Example

14. Discussion Surplus Accumulation Ltd has the following dispositions during FY December 31, 2008 Capital dividends received: $10,000 Capital dividends paid: $5,000 Purchased goodwill for $6,000 in 1998 and has CECA of $2,325 to date Sold an indefinite life franchise for $19,000 in 2008 Land Cost $20,000 Selling cost $1,500 PoD $35,000 Equipment Cost $5,000 Selling cost $100 PoD $500 Securities Cost $3,000 Selling cost $200 PoD $2,000 What is the CDA balance?

15. Discussion Surplus Accumulation Ltd has the following dispositions during FY December 31, 2008 Capital dividends received: $10,000 Capital dividends paid: $5,000 Purchased goodwill for $6,000 in 1998 and has CECA of $2,325 to date Sold an indefinite life franchise for $19,000 in 2008 Land Cost $20,000 Selling cost $1,500 PoD $35,000 Equipment Cost $5,000 Selling cost $100 PoD $500 Securities Cost $3,000 Selling cost $200 PoD $2,000 What is the CDA balance?

16. Alternative format

17. Use of surplus balances Cash, stock, inkind or deemed dividends are treated by a shareholder as having been received in cash Gross up rules apply if individual is receiving the dividend

18. Source of dividends CCPC may have high rate income (GRIP) Composed of: CCPC GRIP balance at end of PY After-tax earnings assuming a 32% tax rate Eligible dividends received by the corporation Reduced by eligible dividends paid LRIP (low rate tax) If a non-CCPC receives dividend from CCPC, then must pay it first

19. Cash or stock dividends Amount of dividend deemed equal to increase in PUC regardless of market value Deemed to be the shareholders ACB

20. Dividends in kind Possible to pay dividends in assets of company Deemed at FMV Acquisition deemed at FMV Dividend deemed to have been paid equal to FMV of assets Losses to corporation on transfer of assets to a controlling shareholder are denied

21. Deemed dividends Anything in equity that is not PUC or capital dividend balance is taxable retained earnings

22. Deemed dividend on increase in PUC May occur when a corporation increases PUC without an increase in net assets (ie sale of property) Exceptions: Increase is from payment of stock dividend Increased as a result of change in FV of assets on issue of shares for cash or conversion PUC of one class is transferred to another Conversion of contributed surplus on issuance of shares into PUC

23. Illustration Facts Results

24. Denied capital loss Capital loss on redemption will be denied if the company and the shareholder are affiliated after the transaction Sale of shares to a spouse for a loss

25. Summary of differences PUC Used to determine the deemed dividend resulting from a redemption or cancellation of shares Calculated at corporate level on a class of shares Changes affect all shareholders equally ACB Used to calculate capital gains or losses Calculated at shareholder level and relates to a particular class of shares and can be unique for each shareholder PUC is always the same for each shareholder

26. Deemed dividend on reduction of PUC Sale of part of company and proceeds are given to shareholders without redeeming the shares For example a distribution of capital of $8 per share on shares with PUC of $10 and there is a reduction of PUC of $7, then there is a deemed dividend of $1

27. Now we get into some good stuff

28. Winding up of a Canadian corporation Disposition of net assets Deemed dividend on windup Components: Capital dividend to the extent of the balance in the company’s capital dividend account if the corporation elects on that amount AND A taxable dividend to the extent of the balance of the deemed dividend

29. Two steps Step 1 – deemed dividend Step 2 – capital gain or loss

30. Application Compute amount available for distribution assuming tax rate of 20%/40% before ART of 6% Determine components of distribution Compute the taxable capital gain or allowable capital loss

31. Solution - available

32. Solution - components

33. Solution – taxable capital gain

34. Summary Winding up is as follows Dispose of all assets at FMV and determine any resulting income or loss and adjustments to the CDA Pay liabilities including tax Calculate RDTOH and assume fully refunded Distribute net proceeds to shareholder, determine a deemed dividend as the excess Elect on an amount not in excess of the CDA Check to see if taxable dividend is sufficient to generate the full dividend refund Compute shareholders gain or loss on disposition of shares

35. Sale of assets vs shares Sale of an incorporated business in two ways Sale of assets Does not assume liabilities Sale of shares Assumes control of assets Assumes responsibilities for liabilities

36. Discussion

37. Option – sale of shares for $130,000

38. Option – sale of assets and windup

39. Option – sale of assets and windup

40. Option – sale of assets and windup

41. Factors to consider By purchaser By CCPC as purchaser By Canadian public company as purchaser By non-resident corporation as purchaser

42. Factors to consider by purchaser Interest on funds borrowed is deductible Cash flow Tax costs Deductibility of loss carryovers

43. Factors for a CCPC Tax advantages will continue (ie SBD) Must be allocated among associated group

44. Factors for public company Loss of SBD Loss of capital dividend account Loss of refundable taxes Impact on cash flows

45. Factors for non resident Loss of SBD Application of withholding taxes Rollovers not available (discussed next week) Acquisition subject to government review Higher expenses for acquisition and lower share value

46. Minimum share price Using straight algebra: P - .46 (1/2 (P - $10,000)) = 110,720 Where P = PoD Solving for P = $140,805

47. More effective amount Pay out capital dividend before the sale (use the opening balance $20,000) Use the same formula as follows 20,000 + P - .46(1/2 (P – 10,000))= 110,720 P = 114,831