Pay Pals: Dividends Don't Always have to be paid in Cash
When it comes to distributing your corporation's profits that have been accumulating on the balance sheet as retained earnings, we often think of declaring and paying a dividend to you, as the owner-manager. While most dividends are paid in cash, it's also possible to pay yourself a dividend "in-kind."
For example, let's say your corporation has been profitable over the past several years and has retained and invested its surplus funds in a portfolio of marketable securities. One of those holdings is invested in a large block of shares of a public but thinly traded corporation. Given the stock's low trading volume, you are concerned that a sale of such a large block of shares on the open market by your corporation could depress the bidding price and result in less-than-optimal proceeds.
To address that concern, you could have your corporation distribute this stock in-kind to you by way of a dividend. From a tax point of view, your corporation is deemed to have disposed of the stock for proceeds equal to the fair market value of the shares so distributed. Depending on the adjusted cost base (ACB or tax cost) of the shares to the corporation, this distribution could result in a capital gain or loss for the corporation.
On the receiving side, you, as the shareholder, are deemed to have acquired those shares at fair market value as a taxable dividend, which would be subject to the normal gross-up and dividend tax credit rules.
Here's an example. Your company, Opco, owns shares in Risky Business Ltd., a junior miner. The shares have an ACB of $10,000 and a fair market value of $100,000. You decide to personally hold the Risky Business shares so you have Opco declare a dividend in-kind and it distributes those shares to you personally, as the 100% shareholder of Opco.
Opco will be deemed to have received proceeds of $100,000 and it will have a capital gain of $90,000 ($100,000 less $10,000), of which 50% is taxable. You, as the shareholder, will be in receipt of a dividend equal to $100,000, which you must gross up on your personal tax return before claiming the dividend tax credit. As a result, the ACB of the Risky Business shares to you for the purposes of calculating any subsequent future personal capital gain or loss would be $100,000.