Taxation Of Shareholders: The Basic Deemed-Dividend Tax Rules

Canada’s Income Tax Act contains several provisions that can treat certain corporate transactions as dividends even when no dividend has been formally declared. These rules, commonly referred to as the deemed dividend rules, are primarily found in Section 84 of the Income Tax Act. Their purpose is to ensure that shareholders cannot extract corporate surplus in a manner that avoids dividend taxation.

As a general principle, shareholders may receive a tax-free return of their invested capital, referred to as paid-up capital (PUC). However, when distributions exceed paid-up capital, Parliament generally intends those amounts to be taxed as dividends rather than as tax-free returns of capital or more favourably taxed capital gains.