What is a Dividend?
Section 160 and 325 Assessments
For the purposes of section 160 of the Income Tax Act and 325 of the Excise Tax Act, payments of dividends to shareholders of a corporation are not considered to be reimbursement for services rendered to the corporation. Therefore, dividend amounts are not included in the consideration calculation.
Dividends are considered to be corporate income distributions to shareholders. According to Canada Revenue Agency’s (“CRA”) Interpretation Bulletin “IT67R3 – Taxable dividends from corporations resident in Canada”:
2. Because there is no specific meaning given to the word “dividend” in the Act, it must be given its generally accepted meaning. Accordingly, any distribution by a corporation of its income or capital gains made pro rata among its shareholders may properly be described as a dividend unless the corporation can show that it is another type of payment. The fact that a distribution of this kind may not be called a dividend does not affect the nature of the distribution. Any interest received on an income bond is deemed under subsection 15(3) to be a dividend where the payer corporation is not entitled to deduct such payment in computing its income. Where an amount is transferred from an unclaimed dividend account of a corporate broker or dealer in securities to a capital or surplus account and is subsequently distributed to the company’s shareholders, the shareholders are in receipt of a taxable dividend.
Dividends paid to Canadian resident shareholders are subject to tax under paragraph 12(1)(j) and section 82 of the Income Tax Act, RSC 1985, c 1 (5th Supp). Paragraph 12(1)(j) imposes the inclusion of dividends from resident corporations as a taxpayer’s income from business or property. Section 82 of Subdivision H of the Income Tax Act is a complex myriad of rules related to the taxation of dividends including, for example, the treatment of various types of dividends such as qualifying, capital and deemed.
Dividends are not Consideration for Services Rendered
Dividends paid from a corporation to a shareholder are not considered to be consideration for services rendered to the corporation, as salary would be. The leading case on this matter is Neuman v Minister of National Revenue, 1998 CanLII 826 (SCC), [1998] 1 SCR 770 (SCC). In Neuman, the Supreme Court of Canada stated at paragraph 57 that:
a dividend is a payment which is related by way of entitlement to one’s capital or share interest in the corporation and not to any other consideration. Thus, the quantum of one’s contribution to a company, and any dividends received from that corporation, are mutually independent of one another.
Similarly, in Mcclurg v. Canada, 1990 CanLII 28 (SCC), [1990] 3 SCR 1020, the SCC stated:
To relate dividend receipts to the amount of effort expended by the recipient on behalf of the payor corporation is to misconstrue the nature of a dividend. As discussed earlier, a dividend is received by virtue of ownership of the capital stock of a corporation. It is a fundamental principle of corporate law that a dividend is a return on capital which attaches to a share, and is in no way dependent on the conduct of a particular shareholder.
Dividends and Sections 160 and 325
The characterization of dividends under the law presents a particular problem in relation to section 160 or section 325 assessments. Pursuant to section 160 of the Income Tax Act and section 325 of the Excise Tax Act, a taxpayer can be held liable for the tax debt of a non-arm’s length person (e.g., spouse, common law partner, closely held private corporation). For example, if a husband with a tax debt transfers the title of the family home to his wife for less than fair-market value, CRA can assess the wife for the husband’s tax debt. For this to occur the transfer must be for less than fair-market value to a spouse or common law partner, a person 18 or younger or a non-arm’s length person.
In the context of a closely held private corporation, shareholders can be held liable for corporate tax debts if they received a dividend from a corporation that owes tax and CRA has been unable to collect from the corporation. As mentioned, under the law a dividend is a return on investment and not consideration, even if the recipient of the dividend believed the amount to be compensation for their work for the corporation.
Therefore, the dividend recipient (a non-arm’s length person) has received a transfer from the corporation for nil consideration, less than fair market value. The transferee shareholder’s liability is up to the amount of the dividend in relation to the tax owing. In contrast, salary is deemed consideration and does not attract similar section 160/325 liability.
Example - Paul v. the Queen, 1998 CanLII 461 (TCC)
In Paul v. the Queen, 1998 CanLII 461 (TCC), the shareholders (who owned all of the shares of their corporation) were assessed for the tax debt of the corporation pursuant to section 160 of the Income Tax Act. During the period at issue dividends were issued to the shareholders. The Tax Court of Canada (referencing the key decision in Algoa Trust et al. v. The Queen, 93 DTC 405) stated at paragraph 7, ‘[s]hareholders receive dividends solely because of the right attributed to their shares, so that no consideration can be said to be given by them therefor…Accordingly, no consideration passed from either taxpayer to [the corporation] in respect of the dividends paid to them.”
Consequently, at paragraph 14, the “Minister correctly assessed the Appellants in accordance with section 160 of the Act, as the Company transferred the Property to the Appellant’s for no, or inadequate, consideration at a time when the company was liable to pay an amount under the Act.”
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