Tax Implications when a Company winds-up its shares?

[HammerRFDer]

Say a corporation has no assets other than cash, and you own shares in it.

They decide to liquidate the stock in the company.

What happens in tax terms? Is this considered a dividend? Would it be eligible for various dividend tax credits if it were from a Canadian corp? Is there a capital loss that one could claim on their tax returns from whatever you paid on the stock to $0?

[pitz]

Say a corporation has no assets other than cash, and you own shares in it.

They decide to liquidate the stock in the company.


Well, you would experience 3 kinds of 'income' from such a liquidation:

1) Return of capital. This is the return of the stated capital of the business.

2) (Eligible) Dividend income. This corresponds to the retained earnings and current earnings of the business, on an after-tax basis.

3) Capital gains. This corresponds to the appreciation in any capital positions of the business.

However, since the business liquidation actually occurs within the business itself, the business pays the capital gains tax, and hence, the capital gains in 3) become dividend income. A corporation cannot 'flow' capital gains out to its owners; only 3 things can possibly ever come from a corporation:

1) Cash or debt obligations;
2) Shares in spun-off entities or in the issuer.
3) A reduction in stated capital (by persmission of the CRA).

A corporation has no right to 'flow' capital gains or losses, or dividends out to its owners without first taking these items onto its income statement, paying taxes, and then, itself, issuing a dividend, subject to the requirements for a dividend as embodied in the Canada Business Corporations Act.



What happens in tax terms? Is this considered a dividend? Would it be eligible for various dividend tax credits if it were from a Canadian corp? Is


Yes. And obviously some of it would flow tax-free as paid-in capital.

Capital losses on business assets would offset capital gains. It is definitely possible for a business, upon being wound up, to distribute shares in assets that have experienced capital loss, at their stated cost base. Those shares could then be dumped at a discount.



there a capital loss that one could claim on their tax returns from whatever you paid on the stock to $0?

Well, if there is a capital loss, that would be reflected in the liquidation value of the shares, and you'd write that amount off on your own taxes.

What size of business are you interested in? If its a small business, or a tightly held business, professional advisors are usually brought in to optimize the winding up process to the tax benefit of the majority shareholder, within the constraints of fiduciary responsibility, of course.

[pitz]

disclaimer: above is not professional or legal advice... go talk to an accountant if the amounts are significant for your particular instance.

[pitz]

Say a corporation has no assets other than cash, and you own shares in it.

What happens in tax terms? Is this considered a dividend? Would it be eligible for various dividend tax credits if it were from a Canadian corp? Is there a capital loss that one could claim on their tax returns from whatever you paid on the stock to $0?

Okay, I was a bit rambling on my earlier post.

I'm going to assume that all of the cash is tax-paid within the corporation, and there is no debt.

Hence, what's left in the business is:

1) Stated Capital
2) Retained Earnings

a) You would receive a distribution of the stated capital of the business. This amount is completely free of taxes.

b) You would receive the retained earnings of the business. This amount, for a Canadian company, would be an eligible dividend, subject to either the preferential eligible dividend rate, or the CCPC rate.

c) Upon receiving the distribution in a), you would reduce your personal Adjusted Cost Base of the shares by the amount received in a).

d) You would then declare a capital gain or loss based on the difference between the value of the wound-up company ($0), and your personal adjusted cost base.

(yes, it is possible for the stated capital to be greater than your adjusted cost base -- especially if the company has been raising equity financing over the years.. For instance, you may have bought into a company at $1/share, but subsequent share issuance was done at $10/share or $100/share. The 'stated capital' on a per share basis is the weighted average of all share issuance, minus any adjustments.)

(having said all this, a shell corporation with a strong retained earnings base, no liabilities (direct, or contingent) and an all cash balance sheet *might* very well be a very attractive item to sell instead of winding up.. If the amounts involved are significant, it potentially could be much more efficient to sell than winding such an entity up.)

[grant]

Just curious, who would be interested in buying a corporation which only has cash & nothing else?

Is it because they can buy it at a discount ($0.80 on the dollar or whatever) and thus have more capital available than if they'd simply made a shareholder's loan to a new corp?

[kaycee8877]

heres maybe a more simpler version ;)

so all you have left is cash in the company and you distribute it to the shareholders

deemed dividend = cash distribution - paid up capital

capital gain/loss = cash distribution - deemed dividend - ACB

the dividend is taxed in personal hands just like a regular dividend. eligible vs ineligible would be completely dependent on the company's GRIP pool - GRIP is past income that has been taxed at the high rate of tax making it 'eligible' for preferential tax treatment in personal hands

a portion of this dividend may also be tax free (capital dividend). As well may trigger a dividend refund in the corporation

[pitz]

Just curious, who would be interested in buying a corporation which only has cash & nothing else?


Well, having embedded tax pools is one reason. The other, I cover below...



Is it because they can buy it at a discount ($0.80 on the dollar or whatever) and thus have more capital available than if they'd simply made a shareholder's loan to a new corp?

Well, the tax rate on dividends is somewhat higher than the tax rate on capital gains, and if the company is a CCPC, under some instances, there are capital gains exemptions which may be utilized if a capital gain is to be realized.

http://www.walterharder.ca/MarginalTaxRateCalculator.html

For instance, put taxable income = $500,000 into the "Taxable Income" calculator, with Ontario. Small Business dividends = 31.34%, Capital Gains = 23.2%.

Obviously, the owner of that business would prefer to sell the business to realize capital gains, versus winding up the business to realize small business dividends at a much higher rate.

In such an instance, the transaction would be done at a price that gives the buyer a discount on the business to its fair value, but gives the seller a premium over its liquidation value on an after-tax basis.

[grant]

let's hypothesize i'm contemplating 2 options to obtain a corporation that has $100k in the bank:

1) buy a corp with $100,000 in the bank, which will be taxed at ~31% when the money is eventually withdrawn via dividends, or
2) create a corp, loan $100,000, which will be taxed at 0% when withdrawn because repaying the loan is an expense.

I would need a ~31% discount to break even in scenario 1. Obviously it's not economical for a seller to sell at a ~31% discount, AND be hit with ~23% capital gains taxes, to cash out of a business, when he could just take the dividends and pay the ~31% in taxes.

So let's say we agree to give him a very tiny tax savings... he gives me 7% discount, and now he's paying ~23% + 7% = 30% tax on his business. That's an extra $1,000 in his pocket.

But now I'm stuck with $100,000 in a corp that will turn into $69,000 as soon as I withdraw it via dividends. Thanks to my discount I'm only losing $24,000 ($100 - $7 = $93, $93 - $69 = $24) But that's still a loss.

So as a purchaser, what's what could motivate me to put my money in a position where it's destined to be taxed like this?