Share question (new shareholder purchasing 20% ownership)

*Technical question

XYZ corporation has one shareholder - 100 common shares with $100 value.
B wants to buy shares & pays $10,000 for 20% ownership.

Two choices:

  1. B receives 25 common share with $25 from corp, remaining 9975 as due to shareholder (loan)
  2. B receives 25 common shares with $10000. The $10000 is shareholder contribution.

What is the tax consequences & risk when paying back the paid capital? which is the best way?

Oh boy… not exactly a question that can be answered without more questions.
You are using 25% in the title but 20% in the question, so I will assume 20%

Are A (current shareholder) & B (prospective shareholder) related to each other ?
Was there a business valuation done confirming the FMV of the corporation to be $50,000?
Could A not sell 20% of his shares to B? (possible CGE?)
If B is subscribing for treasury shares I don’t believe your #1 is an option

1 Like

Deleted by moderator

Snoplowguy raise some good questions. I agree that a third option is for B to buy 20 shares from A for $10,000.

There is some tax ramifications of your two proposed scenario, though I won’t address if there is something else that legally prevents them (as snoplowguy suggests).

Under the first option, both A and B have an ACB (‘Adjusted Cost Base’) of $25 and PUC ('Paid up Capital) of $25. Nice and clean, but they may need another agreement regarding the $9,975 if they don’t want it simply paid back on demand.

Under the second option, A has an ACB of $25, B has an ACB of $10,000, but the total PUC of $10,025 gets allocated evenly to each shares. So that gets allocated as a PUC of $8,020 to A and of $2,005 to B.

I generally don’t like seeing lopsided PUC scenario like this, because of the effect on share redemptions. When you redeem a share, the deemed dividend is calculated as the redemption value less the PUC; but parallel to this there is also a disposal of the shares to report on the T1, which is equal to the PUC less the ACB.

So under option 2, A will have a very low dividends because of his new high PUC, but a high capital gain (overall less personal taxes), whereas B will have a higher dividend and a capital loss.

1 Like

B gets 20% ownership. Originally, 100 common shares issued. The company issues another 25 shares to B. B will get 25/125=20%. (just to clarify)

B is not related to A. Since the money goes to the company, so the company issue shares to B

Business valuation has not been performed, just estimate by shareholders.

wow the reply from the moderator I received was mean and insulting? Why such a personal attack on my character? I don’t think I have been insulted like that since High School or Kindergarden! And by the way educated guy, ever heard of spell check? What is "inproper? Did you mean improper?

Not cool Mr. CGA

BertMulderCGA ](
January 8

am sorry to say so, but you are giving false information. This is a question about a share purchase/sale, not a partnership…

Even regarding partnerships, your answer is all muddled,and your english is inproper…

I don’t have much experience in this area, but very interested in the discussion.

What @snoplowguy suggests re: #1 not being an option - does this fall under section 15 of the ITA? If B buys 20% of a company with all the same rights and privileges as A (i.e. same class of shares), is XYZ allowed to “give” him $9975 worth of potential tax-free returns on his capital?

1 Like

These questions bring back memories of the textbook cases. But yes, as @snoplowguy suggested, you have to ask more questions. Did party B purchase the shares from A or was it from the treasury? In the purchase case, you then have to look at the PUC and do they qualify for lifetime capital gains exemption. If it is from the treasury, then you have to look at the shareholder’s agreement; did it listed the prescribed rate for treasury? If not, is there an FMV? Further, is party B an employee?

Simply put, there is no correct option for you at the moment as there are many unknowns.


The transaction described is that Mr B is purchasing a 20% ownership stake (25 shares) for $10,000.

Choice 1 is not a reasonable option, as it describes Mr B purchasing shares for $25 and loaning the corporation the remaining $9975. Technically speaking, this loan could be paid back to Mr B at some point in the future, making his true investment in XYC corporation only $25. This would be unfair to Mrs A who started the company and had expected to “sell” a 20% interest for 10,000. Realistically speaking, if all ABC Corp needed was a cash injection, Mrs A could have gone to the bank to borrow the $9,975 and would have retained 100% control over the corporation.

Only on Dragon’s Den could I ever see Choice 1 being an option that a business owner might entertain. :slightly_smiling_face:

Choice 2 is a realistic option, whereby the corporation issues 25 shares to Mr B for $10,000. As @fabien states, the PUC of 10,100 (100 + 10,000) would get averaged over the entire 125 shares, which would be a benefit to Mrs A (who only paid $100 for her shares) but a detriment to Mr B later down the road when the corp is wound up. In these situations, you would generally issue a separate class of common shares to Mr B with the same rights and restrictions as the shares that Mrs A holds. Issuing 25 shares of a separate class would allow the PUC of 10,000 to stay with Mr B’s shares. If the Articles don’t allow for the issuance of separate classes, you could file Articles of Amendment.

In this situation, Mrs A holds 100 Class A voting common shares and Mr B holds 25 Class B voting common shares. The capital on the Balance sheet would be 10,100

Choice 3, as mentioned, would be to research the possibility of Mr B purchasing 20 shares directly from Mrs A instead of subscribing for treasury shares. Mrs A could possibly use her CGE if the shares qualify. If liquidity is the underlying issue, then Mrs A could loan the corporation the $10,000 she received from the sale of her shares.


Funds loaned to the corporation is debt financing.
Loan details regarding interest rate, term, callable, etc is specified at the time of the loan. This is separate and distinct from buying shares. The terms such include interest rate, interest payment dates, the term of the loan, if and the loan principal is when callable, and any liens against property.

There are some special rules, Tax Court cases, and administrative policies when loans are non-arms length, related person, and related corporation.

Selling shares is equity financing.

  • Shares can be issued at any price and are a proportional claim based on units against dividends issued to that class of shares.

  • Shares give you a ranked and proportional ownership claim on assets. Preferred first. Common second. Proportional to % of units shares. This is based on units.

  • When issuing new shares at a new valuation there could be a freeze, rollover, reorganization, or deemed dividends.

  • Important concepts include stated capital, paid-up capital, and adjusted cost base.

Stated Capital
A corporation’s stated-capital account tracks the consideration that the corporation received in exchange for issuing its shares—in other words, the account tracks the amount paid by the shareholder to the corporation. The corporation will keep a separate stated-capital account for each class or series of shares. And proper accounting should allow you to discern the stated capital for each issued share.

Paid Up Capital (PUC)
Paid up capital (PUC) measures the contributed capital and capitalized surpluses that a corporation can return to its shareholders on a tax-free basis.

Adjusted Cost Base (ACB)
The adjusted cost base (ACB) is the shareholder’s tax cost for purchasing the shares.

This is a complex topic and, in my opinion, too detailed and complex for the forum.

None the less here are some steps, topics, and references to consider.

Suggested steps

  • Refer to freezing, thawing, butterfly, rollover, etc to get a general overview.
  • Summarize the facts.
  • Identify the relevant sections in the Income Tax Act (ITA) which relate to shares such as ITA Sections 51, 55, 84, 85, 86, 88, etc.


ITA Section 51(1) - Share conversion

ITA Section 55(2) Dividend received as part of a transaction, event, or series of events with the intent to reduce a capital gains.

ITA Section 84 subsection 15(3) - Deemed dividends

**ITA Section 85 and 85(1) ** - Share for share exchange

ITA Section 86 - Exchange of shares in the course of a reorganization of capital

Section 88(1) Dissolution of a corporation. Windup


That’s a lot of information, @dominique.dabolczi! I hope it helps @NiceGuy. But, I’m still wondering if there is anything in the ITA preventing either of the options listed in NiceGuy’s first post. From what @snoplowguy is saying, it sounds like there isn’t - Option 1 might be unfair to shareholder A, but if he/she is willing to bear that unfairness, are there no other tax consequences? Would CRA not question the valuation of the shares? If the FMV of XYZ is $50,000, and B buys 20% of the shares for $25, isn’t there a “shareholder benefit” somehow? I seem to recall that affected the PUC formula, but even if it the PUC was reduced to zero, B is still benefiting.

I suppose if he redeems the shares for $10,000 he will have to pay tax on the entire $10,000 as a deemed dividend, but if he sells the shares to someone else for $10,000, he will pay tax on the capital gain, and the new buyer will end up with shares that have PUC of zero - again, not fair, but is there anything in the ITA to prevent this? Would 55(2) be applied, so that B’s capital gain would be converted to a dividend?

1 Like

If, as the OP has stated, Mr. A’s shares are worth $100, then $25 for 20% of the shares might be ok. The value of the company is the key ingredient. Is it really $100 or is it significantly more than this? The business corporations act requires a share to be issued for value so that is the key factor. Anything less than fmv would contravene the corporations act and I imagine CRA would deem either/both Mr. A & B to have received a benefit for the difference. The shareholder loan doesn’t count as it is repayable. One thing to watch for is that if Mr. B invests in new shares with a large paid-up capital injection, he’ll lose much of that investment to Mr. A unless they have different classes of common shares.


55(2) is really only applicable to corporate shareholders, not individuals. It’s purpose is to prevent surplus or capital gains stripping that would occur by paying out much of the value via tax free dividends to corporate shareholders prior to a business sale. Subsection 55(2) limits or restricts the payment of corporate dividends (including share redemptions) to the “safe income” of the corporation, which might be approximated as its retained earnings. It is sort of the reverse of what you are thinking.

Lets suppose Holdco owns 100 shares of Opco representing 100% of the issued common shares. Opco has been valued at $500,000 and has retained earnings of 200,000. For simplicity sake lets assume that Opco’s “safe income” is equal to its retained earnings of $200,000.

Without the restrictions imposed by ss 55(2) if Opco redeemed its 100 shares for $500,000 it would receive a “deemed dividend” of $500,000. The entire proceeds would be received by Holdco completely free of income tax (usually both part 1 and Part 4 if Opco is not recovering any RDTOH).

In this case subsection 55(2) would step in and reduce the deemed dividend from $500,000 to $200,000 and the other $300,000 would be re-categorized as a capital gain, with 150,000 being a taxable capital gain to Holdco.

Once again, subsection 55(2) is really only applicable to corporate shareholders. If Opco was owned wholly by an individual rather than Holdco, then the entire $500,000 redemption would be a deemed dividend and there would be no capital gains implications on the redemption.

As far as selling shares for less than Fair Market Value, Kevin is correct. The fact that the parties are dealing at Arms Length may help you with the CRA, as it isn’t logical that you would sell an asset to an arm’s length person for an amount less than FMV… so you might be able to argue that the sale price was the FMV.


Oh, that’s right. Thanks for refreshing my memory re: 55(2) @snoplowguy!

1 Like