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Share Redemption Strategies 

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Profession > Tax Strategy

Share Redemption Strategies

Ways to limit taxation on the redemption of shares.


When a shareholder of a private corporation dies, he or she is deemed to have disposed of shares in that corporation at fair market value (FMV) immediately prior to death, unless the shares are rolled over to a spouse, common-law partner, or a spousal/common-law partner trust.

Except in cases where the rollover applies, any capital gain on the shares must be reported in the shareholder’s final income tax return and the estate acquires the shares for an adjusted cost base (ACB) equal to the FMV of the shares immediately before death. However, the paid-up capital (PUC) of the shares is not affected, which may result in double taxation if the shares are redeemed by the corporation instead of sold to a third party.

If the shares are redeemed by the corporation later, whether under a right of redemption attached to the shares or through a purchase by mutual consent, there will be a deemed dividend under subsection 84(3) of the Income Tax Act and a capital loss, as the following example shows.

At the time of his death, Claude held 1000 shares of Private Inc. The shares had an FMV of $2,000,000 and an ACB and a PUC of $20,000. Subsequently, the shares were redeemed by Private for $2,000,000. Since a capital loss can only be deducted from capital gains, it may never be used or it may be years before it can be used. This is where potential double taxation arises: first, as a capital gain in the deceased person’s return, and a second time as a dividend, in the return of the estate or the heirs.

With planning, it is possible to limit double taxation on the redemption of shares. One option is to carry out the share redemption in the first taxation year of the estate in order to make the election under subsection 164(6) of the Income Tax Act. With this election, the capital loss of the estate can be considered as the capital loss of the deceased person, which cancels the capital gain in the deceased’s return.

When an election is made to have the deemed dividend on redemption paid from the capital dividend account, the capital loss on redemption of the shares can be reduced by subsection 112(3.2). The application rules for this subsection are complex. Seek expert advice when this situation arises.

The second technique consists of transferring the shares to a connected holding company before the redemption in exchange for a note for an amount equal to the ACB of the shares for the estate or the heir. The shares are then redeemed. The deemed dividend on redemption becomes a non-taxable, inter-corporate dividend, except for Part IV tax if the payer receives a dividend tax refund. The holding company then pays the note.

Be sure to consider the following:

  • Has the value of the shares increased? If so, a rollover under section 85 will have to be carried out and shares issued for the appreciation since the shareholder’s death.
  • Has the capital gains deduction been claimed for the shares in the deceased person’s return? Then, under section 84.1, the amount equal to the tax-exempt capital gain cannot be removed without tax consequences. Depending on the way that the transaction is structured, there will be an immediate or future deemed dividend.

There are several variations of this second technique. For example, instead of redeeming the shares, one may amalgamate the corporations or wind-up the issuing corporation under subsection 88(1) if the holding company holds 90 per cent or more of the shares.

The best way to proceed in order to limit double taxation on the redemption of shares must be determined after a careful assessment of each case. The two techniques outlined above may seem simple, but there are a number of points to consider to achieve the best result in each case.

Impact on the death of Claude   Impact on the redemption of shares
Proceeds of disposition
$2,000,000 
  Amount received
$2,000,000 

ACB

(20,000)
  PUC
(20,000)
Capital gain
$1,980,000 
  Deemed dividend
1,980,000 
         
Taxable capital gain
$990,000 
  Amount received
$2,000,000 
      Deemed dividend
(1,980,000)
      Proceeds of disposition
20,000 
      ACB
(2,000,000)
      Capital loss
(1,980,000)
         
      Allowable capital loss
$(990,000)

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