Stock dividends or “dividends satisfied by stock” can be a useful tool for a tax practitioner, but do they create their own tax problems for shareholders of a corporation incorporated under the Business Corporations Act (Ontario) (the “OBCA”)?
A stock dividend is a dividend that is satisfied by the issuance of shares of the corporation declaring the dividend. Opco, an OBCA corporation, might declare a dividend on its common shares and issue Class A Special Shares of the corporation in payment of the dividend. Subsection 38(2) of the OBCA provides that
If shares of a corporation are issued in payment of a dividend, the corporation shall add to the stated capital account maintained or to be maintained for the shares of the class or series issued in payment of the dividend the declared amount of the dividend stated as an amount of money.
CRA IT-88R2 describes the income tax consequences of a stock dividend. For tax purposes, a stock dividend is defined as a dividend in the Income Tax Act (Canada) (see the definition of “dividend” in subsection 248(1)). In general, the amount of a stock dividend—the amount to be shown on T5s issued to shareholders who receive the stock dividend—is the amount added to the stated capital account of the shares issued in satisfaction of the dividend (see the definition of “amount” in subsection 248(1) and ¶12 of IT-88R2).
Stock dividends can be quite useful. For example, assume that Mr. X owns 1,000 common shares in the capital of Opco and that these are Opco’s only issued shares. Further, assume that the value of Mr. X’s common shares is $1 million. Mr. X wishes to effect an estate freeze, and he could do so by exchanging his common shares for fixed-value special shares with a total redemption amount of $1 million on a tax-deferred basis under section 51 of the Act. His children could then subscribe for common shares of Opco for a nominal amount.
Mr. X could also use a stock dividend to effect the freeze. He could cause Opco to declare a dividend of, say, $10 to be satisfied by the issurance of special shares with stated capital of $10 and a total redemption amount of $1 million. As a result of the stock dividend, Mr. X’s common shares would become worth a nominal amount. Opco could repurchase Mr. X’s common shares for cancellation, and his children could subscribe for additional common shares. Because only $10 was added to the stated capital of the special shares Mr. X received in satisfaction of the stock dividend, he is required to include only $12.50 (the grossed-up amount of the increase) in computing income for tax purposes (assuming that the dividend is not an eligible dividend under the new dividend tax rules).
As an aside, this method of effecting an estate freeze has the advantage, perhaps, of avoiding the corporate attribution rules because the issue of a stock dividend does not represent a transfer of property that could give rise to the application of subsection 74.4(2) of the Act.
But if Opco is an OBCA corporation, is it permitted to add only $10 to stated capital in respect of the special shares? Arguably, subsection 38(2) of the OBCA actually requires Opco to add the fair market value of the special shares to its stated capital account. Opco must add “the declared amount of the dividend” to stated capital, and some have argued that this must refer to the value of the shares issued in satisfaction of the dividend. (Compare subsection 44(2) of the Alberta Business Corporations Act, which explicitly permits the directors of an ABCA corporation to “add all or part of the value of those shares to the stated capital account maintained or to be maintained for the shares of the class or series issued in payment of the [stock] dividend.” See also subsection 43(2) of the Canada Business Corporations Act.) If that position is correct, then the CRA could argue that Mr. X actually received a dividend of $1 million when he effected the estate freeze because corporate law required Opco to add $1 million to the stated capital account of the special shares issued in satisfaction of the stock dividend.
This was enough of a concern that the Ontario government brought forward a bill to amend, among other things, subsection 38(2) of the OBCA to make it clear that it is not necessary to add the fair market value of shares issued in satisfaction of a stock dividend to the stated capital account of the shares issued. See Schedule “B” to Bill 152, An Act to modernize various Acts administered by or affecting the Ministry of Government Services, 2d Sess., 38th Parl., Ontario, 2006 (2d reading November 16, 2006).
