Deemed dividends — corporate distributions taxed as dividends
Deemed dividend
Section 84 deems certain corporate events to be dividends even when no formal dividend is declared — notably when a corporation reduces its paid-up capital (PUC), winds up, or repurchases shares above PUC.
Plain-language explanation
Section 84 closes the gap that would otherwise allow shareholders to receive corporate value tax-free by labelling it as a capital gain or return of capital. The section deems certain distributions to be dividends, taxed accordingly.
Key provisions:
*s.84(1) — Increase in PUC:* If a corporation increases the paid-up capital of its shares without distributing property to shareholders (i.e., creates a stock dividend by capitalizing retained earnings), the increase is a deemed dividend to shareholders.
*s.84(2) — Winding-up and discontinuance:* When a corporation winds up, distributes assets on dissolution, or returns money on a reduction of paid-up capital, any distribution exceeding the adjusted cost base of the shares is a deemed dividend.
*s.84(3) — Share repurchases (buybacks):* When a corporation buys back its own shares and pays more than the PUC of those shares, the excess is a deemed dividend (not a capital gain on the sale of the shares). This prevents shareholders from extracting corporate retained earnings as lower-taxed capital gains by having the corporation buy back shares.
Interaction with capital gains: The "deemed dividend" reduces the proceeds of disposition for capital gains purposes. The result: on a share buyback, the shareholder gets part treated as dividend and part as capital gain/loss.
Example
Hillside Corp repurchases 1,000 shares from a shareholder for $100,000. The PUC of those shares is $10,000. Under s.84(3), $90,000 is a deemed dividend (taxed with the gross-up mechanism). The remaining $10,000 is the proceeds for capital gains — which equals the PUC, so no capital gain.
Amendment history
Significant changes to this provision. Older versions help you understand rules that applied in prior tax years.
Surplus stripping rules tightened to prevent owner-managers from converting what should be dividends into capital gains through corporate transactions. S.84(2) scrutiny increased; combined with s.84.1 anti-avoidance, the eligible surplus stripping strategies narrowed significantly.
Before
Some corporate reorganizations allowed the conversion of corporate surplus to capital gains
After
Tightened combination of s.84(2), s.84.1, and GAAR prevents most surplus-stripping arrangements
Common questions
What is paid-up capital (PUC)? +
The amount shareholders paid into the corporation in exchange for shares — roughly the original share subscription price adjusted for technical rules. It is the portion of a share's value that can be returned to shareholders tax-free (without triggering a deemed dividend). Retained earnings are not PUC.
If my corporation buys back my shares, do I pay dividend tax or capital gains tax? +
Usually a mix of both. S.84(3) deems the excess over PUC to be a dividend. The capital gain or loss is on the remaining proceeds minus your ACB. For most closely held corporations with low PUC and high retained earnings, most of the buyback proceeds will be treated as a deemed dividend.
Is a return of capital the same as a dividend? +
No. A true return of capital (returning your original investment equal to PUC) is not income — it just reduces your ACB. A deemed dividend under s.84 arises when the distribution exceeds PUC.
Key terms
Related sections
CPA recommendation
Corporate reorganizations involving share redemptions or buybacks require CPA or tax-lawyer review to manage the s.84 deemed dividend and capital gain outcomes.
Source: Income Tax Act, RSC 1985, c. 1 (5th Supp.), section 84. — Read the official text on Justice Canada
These summaries are for educational purposes only and do not constitute legal or tax advice. Speak with a CPA for advice on your specific situation.