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Share redemption, deemed dividends and capital losses
May 9, 2021
9:17 am
jane7
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Hello income-tax-savvy people,

I am trying to understand whether I can report capital losses in the following situation:

I had 100 shares of the company I worked for, originally bought for $10/share. Last year, that company repurchased my shares at $7/share. Apparently, such redemption deems me to have received a deemed dividend to the extent that the redemption proceeds exceed the shares’ paid-up capital, and I received a T5 slip. I was informed that this deemed dividend is an ineligible dividend for tax purposes, whatever that means.

So, my question is whether I can calculate and report my capital loss as I normally would when I buy high and sell low, or if this deemed dividend thing changes something. I’d appreciate your insights!

May 9, 2021
1:41 pm
Bill
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jane7, I found this on the internet, maybe it helps:

"A share redemption occurs when a corporation purchases its shares from a shareholder and cancels those shares. Subsection 84(3) deems the shareholder to have received a dividend to the extent that the redemption proceeds exceeded the share’s PUC.
But when computing the capital gain for disposing the shares, the shareholder offsets the redemption proceeds by the amount of the deemed dividend. This ensures that the shareholder’s redemption proceeds aren’t double taxed as both deemed dividends and capital gains
For example, a corporation redeemed its shares and paid the shareholder $200. The shares had a PUC of $75, and the shareholder’s ACB for the shares was also $75. As a result, the shareholder received a deemed dividend of $125 ($200 redemption price minus $75 PUC). And the shareholder’s capital gain is nil ($200 proceeds of disposition minus $125 deemed dividend minus $75 ACB)."

May 9, 2021
3:07 pm
Norman1
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For tax purposes, the company did not purchase your shares for $7/share.

Instead, company paid you a dividend and purchased your shares for its paid-up capital value. So, if paid-up capital was $2/share, then company bought your shares for $2/share and paid you a dividend of $5/share.

If the shares were bought for $10/share, then there would be a capital loss of $10 - $2 = $8/share.

The dividend in your case is known an "other than eligible" dividend. It has a different gross-up and different dividend tax credit from an "eligible" dividend. That is because the company paid the small business corporate tax rate (not the regular corporate tax rate) on the taxable income that dividend is from.

Hopefully, the paid-up capital value is closer to $7/share than to $2/share. One is kind of screwed in such situations because one ends up declaring part of one's original investment as dividend income and paying taxes on it! sf-frown

Considerate companies will incorporate a separate company to buy its shares back. That way, it is a regular purchase for $7/share for tax purposes.

May 9, 2021
4:02 pm
Bill
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But some good news is that even though in real life you lost $3 per share your capital loss for income tax will be greater, i.e. in Norman1's example, you have an $8 capital loss which can then be applied against any present or previous 3 years or future other capital gains. So not as good as just having a $3 capital loss with no dividend income to report but mitigated to some extent.

May 9, 2021
4:21 pm
jane7
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Thank you Bill and Norman1 for your responses! This makes a lot more sense now. I would not call my enormous capital loss good news exactly, but anyways...

I was paid $7/share, the ACB is $10, the PUC in my case is $3.6, and thus the deemed dividend is $3.4. So according to your examples, my capital gain should be $7 minus $3.4 minus $10 = ($6.4). Or, my capital loss is $10 minus $3.6 = $6.4.

Thanks again!

May 9, 2021
5:39 pm
Bill
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Agreed, the way I look at it is you add to your actual capital loss ($3) the additional deemed dividend amount ($3.40) that you had to include in your income, thus $6.40 is your total capital loss.

May 9, 2021
8:20 pm
Norman1
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The Schedule 3 line will look something like this:

Proceeds Adjusted
Cost Base
Outlays &
Expenses
Gain
$360.00 $1,000.00 $0.00 ($640.00)

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