CHAPTER 12:

Organization, Capital
Structures, and Income
Distributions of
Corporations
Prepared by

Kristie Dewald
University of Alberta
Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Education Limited

Organization, Capital Structures, and Income

Distributions of Corporations
I. Corporate Capitalization Debt or Equity
II. Transferring Assets to a Corporation
III.Corporate Distributions to Shareholders

I.

Corporate Capitalization Debt or Equity

Creating a Corporation requires at a minimum, share

capital be issued in return for some consideration
Equity - Share

Shareholder

Corporation
Cash or Assets

must have a capital base for acquiring assets and conducting

business.
Capital base contributed can be in the form of debt (shareholder
loan or from non-shareholders) or equity (additional share
capital).
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I. Corporate Capitalization Debt or Equity

Shareholders perspective,
debt and equity are capital property for tax purposes, and
yield a return on investment in the form of interest or dividends.

Debt and equity are subject to capital gains treatment.

Capitalizing of a corporation by shares and debt:
Most often found in closely held private corporations
The affairs of the corporation and shareholders are closely
linked.

I. Corporate Capitalization Debt or Equity

Capitalization by share equity or by a combination of
share equity and shareholder debt has advantages
and disadvantages
Functions of tax treatments resulting from:
1. Return on invested capital
Interest vs. dividends

2. Losses when shares or loans are disposed of, and

3. Return of original capital

A. Corporate Capitalization
by Shareholder Debt
Return on investment:
Shareholder loans may bear some rate of interest or be
interest-free.
Interest paid by the corporation is deductible for tax purposes.

Corporate Capitalization by Shareholder

Debt - An example
Corp X is subject to tax of 27% and earns business income
of $1,000 before the payment of interest. Shareholder loan
of $10,000 can have 10% interest or none. Shareholders
personal income tax rate is 50%.
What is the combined tax rate with and without paying
interest on the shareholder loan?

Corporate Capitalization by Shareholder

Debt an example
10% interest
Corporation:
Business income $1,000
Interest paid
(1,000)
Income for tax purposes
Corporate tax
0
Shareholder (individual)
Interest income
$1,000
Personal tax
$500
Combined tax
$500

No interest
Corporation:
Business Income $1,000
Interest paid
(0)
Income for tax purposes $1,000
Corporate tax
270
Shareholder (individual)
Potential dividend $730
Personal tax
$256
Combined tax
$526

A. Corporate Capitalization
by Shareholder Debt
Loss of investment
A loss incurred on shareholder debt is a capital loss,
only one-half is deductible for tax purposes.

If loan is to a small business corporation,

the capital loss becomes a business investment loss
one-half of the loss can be offset against all other sources

A loss on a loan is recognized for tax purposes in the

year in which it is established to be uncollectible.
Usually earlier than a loss on share capital

A. Corporate Capitalization
by Shareholder Debt
Return of capital:
Capital contributed in form of debt can be returned with relative
ease and without tax consequences.
It is simply a repayment of loan principal.

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B. Corporate Capitalization by Share Capital

Return on investment
Share capital provides a return in form of dividends.
Dividends are
not deductible by the corporation and
are taxable to the individual shareholder.

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B. Corporate Capitalization by Share Capital

Loss of investment
A loss on a share capital investment is normally a capital loss,
of which one-half is recognized for tax purposes.

Share capital loss is recognized only in the year in which:

the shares are disposed of, or
Corporation becomes legally bankrupt, or
Corporation is insolvent and has ceased operations.

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B. Corporate Capitalization by Share Capital

Return of capital
There are two ways to acquire shares in a corporation:
1. Purchase previously issued shares from other
shareholders, or
2. Purchase directly from the corporation, new shares
issued
Each has different tax implications when sold or redeemed

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Acquiring Shares
1. From the corporation directly
No tax consequence when shares received
Stated value of shares is referred to as paid up capital (PUC) and
is equal to value of consideration received.

2. From other shareholders:

No funds are contributed to the corporation
Acquired shares have an adjusted cost base (ACB) equal to
the purchase price
Paid up capital of the shares remains unchanged.

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Sale of Shares
3. Sale of Shares to Other Shareholders:
Capital Gain = Sale Price > Purchase Price
Capital Loss = Sale Price < Purchase Price

4. Sale of Shares Back to the Corporation:

Referred to as a share redemption or buy-back.
Involves
distribution of corporate assets and
a cancellation of all or some of their shares.

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Sale of Shares Back to the Corporation

Tax consequences when a redemption occurs are as
follows:
1. Redemption price > exceeds the paid-up capital (PUC) =
Deemed Dividend
2. For Capital Gains (loss) purposes:

Shares deemed to be sold at amount = to the PUC of the shares.

When redeeming corporate shares, the company:

.cannot simply repay the original share capital but
.also must distribute the attached retained earnings as a
dividend.
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Sale of Shares
Back to the Corporation
S/H #1

S/H #2

50%
Value $50,000

50%
Value $50,000

Before
Corporation
PUC $ 10,000
R/E
90,000
$100,000

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Sale of Shares
Back to the Corporation
S/H #1
50%
Value $50,000

After
Corporation
PUC $ 5,000
R/E
45,000
$ 50,000

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Sale of Shares Back to the Corporation

Example
Shareholder acquired shares directly from the
corporation for $5,000 cash:
PUC = $5,000
ACB = $5,000

Shares were redeemed by the corporation for

$50,000
Tax consequences to the shareholder are:

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Sale of Shares Back to the Corporation

Example
Deemed dividend:
Redemption price $ 50,000
Paid-up capital (5,000)
Dividend to shareholder 45,000
Capital transaction:
Deemed proceeds of disposition $ 5,000
Adjusted cost base (5,000)
Capital gain/loss -020

Reduction of Paid-up Capital

PUC can be returned without redeeming shares.
The tax treatment varies depending on the type of
corporation:
Public corporation
Any return of capital is normally considered a taxable
dividend for the entire payment.

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Reduction of Paid-up Capital

Private corporation can return capital with no tax
consequences provided:
the payment reduces PUC and
does not exceed PUC.
Amounts exceeding PUC = Deemed dividend
Fully taxable

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II.

Transferring Assets to a Corporation

Transfer of assets constitutes a sale and disposition.

Fair Value > purchase price = tax implications.
Existing or proposed shareholder can transfer an asset
at:
FMV or
at an elected value,
normally equal to the assets cost for tax purposes.

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A. Transfer of Assets at Fair Market Value

Gains are recognized.
Resulting income depends on nature of the asset:
Capital gain,
recapture of CCA, or
Normal business income.

Corporation:
Assets acquired at FMV increases the tax cost that may,
reduce the taxes payable by the corporation.

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Transfer at Fair Market Value

An example
Original Cost = $100,000
UCC = $60,000
FMV = $90,000
S/H tax rate = 50%
Corporation tax rate = 27%

Shareholder

Corporation

Proceeds
$90,000 Capital cost
$90,000
UCC
(60,000) Original UCC
(60,000)
Taxable income
$30,000 Additional dedn $30,000

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B. Election to Transfer Assets at Tax Values

The Act permits assets to be transferred to a
corporation at their tax cost.
Permitted even though the transfer price for legal
purposes may be at FMV.
Election is called a rollover
shareholders personal taxable income is rolled over to the
corporation but not eliminated.

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B. Election to Transfer Assets at Tax Values

Election limitations
Corporation can pay in the form of share or non-share
consideration.
Tax-Free transfer:
Consideration must include some shares,
non-share consideration:
cannot be > elected value.
i.e. cash,
note
receivable,
debt

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B. Election to Transfer Assets at Tax Values

Tax implications:
Defers tax to the shareholder at the time of the transfer.
There will be future tax implications.

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C. Applying the Election Option

Assets eligible for transfer at tax cost are:
1. Capital property,

depreciable and
non-depreciable

2. Inventory
3. Eligible capital property
4. Resource property
Exceptions:
Real estate held for resale
Real estate owned by a non-resident
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C. Applying the Election Option

Use of the election:
1. Proprietorship to Corporation - where the proprietor
becomes the shareholder.

Corporation

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C. Applying the Election Option

2. Transfer assets from parent to new or existing
subsidiary.
Parent
Corporation

Sub
Corporation

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C. Applying the Election Option

3. Transfer assets from one sister corporation to another
within the corporate group.
Parent
Corporation

Sub A
Corporation

Sub B
Corporation

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C. Applying the Election Option

4. A corporation or an individual can sell assets to an
unrelated third party and defer tax by using the
election.

Seller must become shareholder of purchasing corporation.

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D. Accounts Receivable
A loss on the transfer of accounts receivable results
in a capital loss to the vendor
One-half of the loss is deductible against capital gains

IF sale is to an affiliated person:

capital loss is deemed to be nil,
Purchaser deemed to have acquired a capital property
Subsequent gains or losses are capital

May file a joint election to treat sale of accounts

receivable as business for both parties

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III.Corporate Distributions to Shareholders

Corporate distributions consist of either accumulated
profits or the return of capital.
A. Stock dividends
Involve the issuing of additional shares in lieu of a cash.
Corporation

no tax or cash implications.

Shareholder

normal taxable dividend.

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III.Corporate Distributions to Shareholders

B. Special Distributions of CCPC
Certain income earned by a corporation is tax-free:
Life insurance proceeds
Non-taxable portion of capital gain.

These amounts may be distributed by private corporations as a

capital dividend
Tax-free
Requires a special election

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III.Corporate Distributions to Shareholders

C. Distributions Other than Cash
A corporation can pay a dividend by transferring ownership of
corporate assets to the shareholder (dividend in kind).
Corporation: Asset Value > tax cost,
Disposal = FMV results in taxable income.

Shareholder: Taxable dividend = FMV of the asset received.

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III.Corporate Distributions to Shareholders

D. Wind-up of a Corporation
A corporation can end its existence by:
disposing of all its assets,
meeting its debt obligations, and
distributing all its earnings and capital to the shareholders.

Corporation deemed to sell assets at FMV

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Chapter 12 Supplement
Section 85 Detailed Rules
Who Can Make The Transfer
Taxpayer - Form T2057-includes:
Individual
Trust
Corporation

Partnership - Form T2058

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Section 85 Transfer price

Elected Amount becomes:
Sales proceeds - transferor
Cost of property received - transferor
Cost of asset - corporation (purchaser)

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Section 85 Allocation of Elected Amount

Elected Amount is allocated as follows:
1st to Non-share consideration (up to FMV)
Next, to Preferred Shares (up to FMV)
Lastly, to Common shares (remainder)

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Section 85 - Consideration
FMV of consideration received must equal FMV of assets
transferred
If not, adverse tax consequences will occur

No tax implication as long as:

Consideration includes shares
Total consideration = elected amount
No tax if elected amount = tax costs

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Section 85 Elected Amounts

Non-Depreciable Property
Lesser Of
FMV of the asset
ACB of the asset (tax value)

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Elected Amount: Non-Depreciable

An example
ACB = $20,000
FMV = $100,000
Elected amount between $20,000-$100,000
Elected at $20,000 = No tax implications on transfer
Proceed of Disposition to transferor = $20,000
Cost of Asset to corporation = $20,000

Result is that capital gain is deferred

until the corporation sells the asset
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Section 85 Elected Amounts

Depreciable Capital Property
Least Of
FMV of the asset
Cost (original) of the asset
UCC of the asset

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Elected Amount: Depreciable

An example
COST = $40,000
Elect between
FMV = $100,000
$30,000-$100,000
UCC = $30,000
Elected at $30,000 = No tax implications on transfer
Proceed of Disposition to transferor = $30,000
Cost of Asset to corporation = $30,000

Result is that capital gain is deferred

until the corporation sells the asset

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Elected Amount: Depreciable

An example
COST = $40,000
Elect between
FMV = $100,000
$30,000-$100,000
UCC = $30,000
Elected at $50,000 Means POD = $50,000:
Tax Implications to transferor:
Capital Gain = $50,000 less $40,000 = $10,000
Recapture = $40,000 less $30,000 = $10,000

Cost to Corporation
$45,000 = $30,000 + $15,000

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Section 85 Elected Amounts

Eligible Capital Property
Least Of
FMV of the asset
ACB of the asset
Cost of the asset

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Elected Amount: Eligible Capital Property

An example
COST = $40,000
Elect between
FMV = $100,000
$24,000-$100,000
CEC = $18,000
Elected at $24,000 Means POD = $24,000:
Transferor:
Capital Gain = $0 = $24,000 - $40,000 -cannot have a capital loss
therefore $0
Recapture = $0 = $18,000 - (3/4 X $24,000)

Corporation
Cost = $24,000
CEC = $18,000 = x 24,000

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