Introduction: Winding-up a Corporation and Corporate Law
Under Part XVI of the Business Corporations Act (Ontario), a winding-up involves a corporation's assets being sold or distributed, its debts and liabilities being settled and its shares being cancelled. On the one hand, a corporation's business may be wound-up without affecting the corporation's existence where funds or property of a corporation are distributed or appropriated to or for the benefit of its shareholder for the purpose of winding-up, discontinuing or reorganizing its business. On the other hand, the winding-up or dissolution of a corporation will result in ending both the corporation's existence and its business (Canada Business Corporations Act Part XVIII). A corporation is considered to be wound-up where it has (1) complied with the winding-up and dissolution procedures set out in its governing statute (federal or provincial business act or the Winding-up Act); or, (2) carried out a winding-up and it has been dissolved pursuant to its incorporating statute. Needless to say, a winding-up will have various tax consequences for the corporation and its shareholders, some of which may be affected by certain provisions in the Income Tax Act such as subsection 88, which is discussed further below.
The winding-up of a corporation may be voluntary, based on shareholder approval by a special resolution (Business Corporations Act (Ontario), subsection 193(1)). However, in some instances a corporation may be wound-up as a result of a court order (Business Corporations Act (Ontario), subsection 193(3)). In Ontario, a winding-up is governed provincially by the Business Corporations Act (Ontario) or federally by the Canada Business Corporations Act or by the federal Winding-up Act.
Tax Reasons for Winding-up a Corporation
The winding-up of a corporation can be an effective tax planning tool that can be used for various reasons including, but not limited to:
- Achieving corporate and or tax objectives;
- Ending a corporation's business;
- Terminating a corporation's business activities;
- Simplifying and or consolidating a corporate structure;
- Minimizing compliance and administrative costs for related corporations; and,
- Utilizing tax losses after the winding-up.
Significant Legal Concepts – Taxable Canadian Corporation, Subsidiary, Parent Corporation, and Subsidiary body corporate.
To better understand the wind-up rules under the Income Tax Act, this section discusses the following significant concepts: taxable Canadian corporation, parent corporation and subsidiary body corporate.
Taxable Canadian corporation is defined under subsection 89(1) of the Income Tax Act as a corporation that, at the relevant time, was a Canadian corporation and was not exempt, by virtue of a statutory provision, from Part I tax under the Act.
Under subsection 88(1) a "subsidiary" is a taxable Canadian corporation that has 90% of its issued shares of each class of capital owned by another taxable Canadian corporation.
Pursuant to subsection 88(1) of the Income Tax Act, where not less than 90% of the subsidiary's issued shares, immediately before the winding-up, are owned by another taxable Canadian corporation, the latter is referred to as a parent corporation. In context of winding-up, all the remaining shares of the subsidiary (that were not owned by the parent corporation immediately before the winding up) must be owned by persons with whom the parent corporation is dealing at arm's length.
Pursuant to section 2 of the Canada Business Corporations Acts, a subsidiary body corporate is a subsidiary of another body corporate if:
- it is controlled by
- that other body corporate,
- that other body corporate and one or more bodies corporate each of which is controlled by that other body corporate, or
- two or more bodies corporate each of which is controlled by that other body corporate; or
- it is a subsidiary of a body corporate that is a subsidiary of that other body corporate.
The Definition of Winding-up Under the Income Tax Act
The term "wind-up" is not defined under the Income Tax Act. Subsection 84(2) of the Income Tax Act applies in the context of winding-up the business conduct of a corporation or winding-up the corporation's existence. However, subsections 88(1) and 88(2) only apply to winding-up the corporation's existence, subject to certain restrictions.
Winding-up a Canadian Corporation and Subsections 88(1) and 88(2) of the Income Tax Act
Section 88 of the Income Tax Act is precisely designed to ensure that, after the winding-up of a 90% subsidiary corporation into its parent corporation, that subsidiary's losses (including non-capital losses and net capital losses) are available for use by the parent corporation, subsection to certain restrictions.
Subsection 88(1) of the Income Tax Act applies where a "taxable Canadian corporation" has been wound-up into a parent taxable Canadian corporation that owns at least 90% of the shares of each class, immediately before the winding-up. Under paragraph 88(1)(a), property of the subsidiary corporation that is disposed of and distributed to its parent corporation on a wind-up shall be deemed to be disposed of by the subsidiary (to its parent) for proceeds equal to the subsidiary's cost amount. In this context, the proceeds of disposition of cancelled shares should be equal to the amount of money and property of the corporation that distributed (the proceeds) to its shareholders as a result of the winding-up. Subsection 88(1) excludes Canadian or foreign resource property.
Paragraph 88(1)(b) deals with the disposition of the parent's shares of its subsidiary upon the wind-up (of the subsidiary) and determines the parent's proceeds of disposition of those shares, which are cancelled on the winding-up. Specifically, Paragraph 88(1)(b) provides that the shares of the subsidiary that are owned by the parent, immediately before the wind-up, shall be deemed to have been disposed of by the parent corporation on the wind-up for proceeds that is equal to the greater of:
- the lesser of the paid-up capital in respect of those shares immediately before the winding up; and,
- the total of all amounts each of which is an amount of any share of the subsidiary so disposed of by the parent on the winding-up, equal to the adjusted cost base to the parent of the share, immediately before the winding-up.
Further, paragraph 88(1)(c) of the Income Tax Act deals with the parent's acquisition of property that is distributed to it (by the subsidiary) upon the winding-up (of the subsidiary corporation). Under paragraph 88(1)(c), the parent's cost of each property of the subsidiary that is distributed to the parent on the winding-up (of the subsidiary) is deemed to be the amount determined in paragraph 88(1)(a). Consequently, the parent corporation acquires the distributed property at the subsidiary's cost of that property.
Under subsection 88(1.1) of the Income Tax Act, non-capital losses of a subsidiary corporation may be carried forward and deducted in computing the parent corporation's taxable income, but only in a taxation year of the parent that following the winding-up of the subsidiary. Losses in the subsidiary corporation cannot be carried back to any prior taxation year of the parent corporation that started before the winding-up (of its subsidiary corporation commenced). Further, losses in the parent corporation cannot be carried back to any taxation year of its subsidiary corporation. Non-capital losses are deductible by the parent corporation only if they have not already been deductible by the subsidiary corporation in computing its corporate taxable income (paragraph 88(1.1)(b)).
Accordingly, subsection 88(1) provides comprehensive tax deferral treatment for the corporation and its shareholder where a taxable Canadian corporation is wound-up into a taxable Canadian corporation of which it owns at least 90% of the shares of each class of the subsidiary. Specifically, subsection 88(1) is designed to allow a tax-free rollover with respect to property distributed to the parent and shares of the subsidiary corporation held by the parent. In Canada v Mara Properties Ltd., the Federal Court of Appeal upheld the Tax Court of Canada's decision to permit the application of subsection 88(1) of the Income Tax Act with respect to land acquired by a parent corporation as a result of the winding-up of its subsidiary. In that case, the Federal Court of Appeal explained that subsection 88(1) is a rollover provision that deems a "disposition and acquisition of a subsidiary's property to have accrued at the subsidiary's cost, and to defer its fiscal consequences until the parent actually disposes of the property by sale or otherwise."
However, the rollover rules under subsection 88(1) do not apply to minority shareholders. Further, where a Canadian taxable corporation is wound-up into a Canadian taxable corporation that does not own at least 90% of the shares of each class of the subsidiary, the rollover rules under subsection 88(1) are not applicable.
Subsection 88(2) of the Income Tax Act applies where a Canadian corporation has been wound-up and where subsection 88(1) does not apply. That is, where a Canadian corporation (other than a subsidiary to the winding-up that is governed by subsection 88(1)) is wound-up and at a specific time in the winding-up, "all or substantially all of the property owned by the corporation before that time was distributed to the shareholders of the corporation."
Subsection 88(2) ensures that a corporation's "capital dividend account," "capital gains dividend account" and "pre-1972 capital surplus on hand" reflect the disposition of funds or property by the corporation on the winding-up. However, in circumstances where subsection 88(2) does not apply, a dividend paid on a winding-up will be a taxable dividend and such amount must be included in the shareholder's income.
Winding-up and Subsection 84(2) of the Income Tax Act
As previously mentioned, in a winding-up or discontinuance of a corporation, the corporation sells its assets, pays off its outstanding liabilities and distributes the remaining cash among its shareholders in exchange for their shares, resulting in the cancellation of the shares that will give rise to tax effects for its shareholders.
Under certain circumstances, subsection 84(2) of the Income Tax Act may apply to the distribution or appropriation of "funds or property" of a Canadian resident corporation "to or for the benefit of shareholders [..], on the winding-up, discontinuance or reorganization of its business". In this context, the corporation is "deemed to have paid [..] a dividend on the shares [..] equal to the amount, if any, by which":
- the amount or value of the funds or property distributed or appropriated, exceeds
- the amount, if any by which the paid-up capital in respect of the shares of that class is reduced on the distribution or appropriation.
This means that in a situation where the corporation distributes property to its shareholders on winding-up, amounts distributed that exceed the paid-up capital of such shares will be treated as a taxable dividend. Subsection 84(2) may apply in certain cases with the result that shareholders are deemed to receive a dividend that is equal to the amount of the fair market value of the property distributed by the corporation (to the shareholder) in excess of the paid-up capital that of that property. Further, shareholders are also deemed to have disposed of their shares in the wound-up corporation. Therefore, to avoid double taxation on liquidation proceeds, shareholders must reduce the amount received by the amount of the deemed dividend when computing the taxable capital gain for disposition of shares.
If there is no true winding-up, discontinuance or reorganization of the corporation, the deemed dividend rules under subsection 84(2) do not apply, as was the case in the Federal Court of Appeal decision Canada v. Vaillancourt-Tremblay. In this case, the Federal Court of Appeal explained that subsection 84(2) prevents corporations, upon winding-up, discontinuance or reorganization "from issuing to shareholders what should be taxable earnings in the form of an ostensibly tax-free return of paid-up capital, by deeming amounts distributed in excess of paid up capital to be taxable dividends." The Federal Court of Appeal held that subsection 84(2) did not apply where a corporation was sold with no distribution or appropriation of its assets and the relevant transaction constituted a share for share exchange under subsection 85.1(1) of the Income Tax Act.
Pursuant to paragraph 88(1)(d.1) of the Income Tax Act, subsection 84(2) will not apply, where subsection 88(1) applies. However, subsection 84(2) will likely "apply on the winding-up of a corporation that is subjection to the provisions of subsection 88(2)."
Tax Consequences of Winding-up a Canadian Corporation
Under subsection 84(2), corporate distributions to shareholders upon winding-up, discontinuance or reorganization of the business in excess of the share's paid-up capital constitutes a taxable deemed dividend. To avoid double taxation on liquidation proceeds, shareholders can reduce the amount received by the amount of the deemed dividend when computing the taxable capital gain for disposition of shares. Consequently, winding-up a business that a corporation conducts or the existence of a corporation under subsection 84(2) of the Income Tax Act will likely lead to certain transactions, such as share redemption, that can give rise to tax obligations for its shareholders in the form of a taxable dividend.
Subsection 88(1) of the Income Tax Act does not apply where the corporation being wound-up is not a taxable Canadian corporation or the corporation's shares are owned by an individual or a group of individuals (as opposed to a taxable Canadian corporation). In addition, subsection 88(1) does not apply where 90% of the subsidiary is not owned by a taxation Canadian corporation. Further, where subsection 88(2) does not apply, the winding-up dividend distributed among the shareholders of the corporation will be deemed to be a taxable dividend and must be included in the shareholder's income, pursuant to subsection 84(2) of the Income Tax Act.
Pro Tax Tips - Winding-up a Canadian Corporation
Winding-up a corporation's business operations or the corporation's existence can be a significant and flexible tool for achieving effective business and tax planning objectives. However, winding-up is a complex area of law that requires detailed analysis and advice from an experienced Canadian tax lawyer. If you have a complex business structure, then considering the winding-up of a corporation's business conduct or the corporation's existence may be ineffective tax planning strategy. You should consider obtaining advice from an experienced Canadian tax lawyer on how the above-mentioned rules may impact the subsidiary, parent, shareholders and your tax planning objectives. If you have questions pertaining to the winding-up rules under the Income Tax Act, please contact our tax law office to speak with one of our experienced Certified Specialist in Taxation Canadian tax lawyers
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.