Can I pay a dividend before I sell my shares, and what are the tax rules?

A dividend before a sale moves cash out of the company and into the shareholders’ hands instead of leaving it for the buyer to pay for. Two questions follow: whether the company may pay it, and how it is taxed, which depends on whether the shareholder is a person or a corporation.

Whether the company may pay it

The Canada Business Corporations Act says a corporation shall not declare or pay a dividend if there are reasonable grounds for believing it is, or after the payment would be, unable to pay its liabilities as they become due, or that the realizable value of its assets would then be less than its liabilities and stated capital. Ontario’s Business Corporations Act has a matching test and makes the directors’ power to declare subject to the articles and any unanimous shareholder agreement. Other provinces have their own statutes.

How an individual shareholder is taxed

Section 82 of the Income Tax Act includes in income the taxable dividends a taxpayer receives from corporations resident in Canada, and treats eligible dividends separately; the rate is a question for your accountant. What matters here is the label. A dividend is income, while a gain on the shares is a capital gain, which the CRA says the capital gains deduction may reduce when the shares are qualified small business corporation shares.

If a holding company owns the shares

Subsection 55(2) can apply to a taxable dividend received by a corporation resident in Canada that is entitled to a deduction for it. If the dividend is part of a series, one purpose is a significant reduction in a gain or in a share’s value or a significant increase in the cost of property, and the dividend exceeds the income that contributed to the gain, the Act deems it not a dividend and treats it as proceeds or a capital gain; subsection 55(3) lists exceptions. Treadstone Law notes that safe income planning matters only where the seller is itself a corporation. See safe income.

What it does to the deal

A dividend takes value out of the company, so the shares can be worth less to a buyer afterwards. It can also change whether the shares qualify for the deduction, because the Act’s definition looks at the mix of the company’s assets at the time of the sale and over the previous 24 months. Purification covers that planning.