15 January 1990 Administrative Letter 74486 F - Deemed Dividend on Redemption of Inventory Shares

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Subject:  Your File  F-3273 Deemed Dividend under subsection 84(3) of the Income Tax Act (the "Act") on the redemption of inventory shares

This is in reply to your memorandum of October 27, 1989 in which you requested confirmation of our understanding of the Department's current position on the tax treatment of the redemption of shares held as inventory rather than as capital property.

As you point out, the position taken by the Department in the 1984 Revenue Canada Round Table is that the difference between the proceeds of disposition and cost is included in income under subsection 9(1) of the Act and that subsection 4(4) of the Act applies to prevent any deemed dividend arising under subsection 84(3) of the Act on the redemption from also being included in income.

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Our current position is that, upon a redemption of a share held as inventory rather than as capital property:

(a)     the difference between the redemption amount and the paid-up capital of the share is deemed to be a dividend paid to, and received by, the shareholder by virtue of subsection 84(3) of the Act;

(b)     unless the corporation elects capital dividend treatment in respect of the deemed dividend pursuant to subsection 83(2) of the Act, the amount of the dividend will be included as business income of the recipient by virtue of paragraphs 82(1)(a) and 12(1)(j) of the Act;

(c)     if the shareholder is an individual described in paragraph 82(1)(b) of the Act, an additional amount equal to 1/4 of the deemed dividend will be included in computing the business income of the shareholder by virtue of paragraphs 82(1)(b) and 12(1)(j) of the act and such shareholder will be entitled to a dividend tax credit in respect thereof by virtue of section 121 of the Act;

(d)     if the shareholder is a corporation described in subsection 112(1) of the Act, it will be entitled to a deduction under subsection 112(1) in respect of the deemed dividend provided that the dividend is a taxable dividend and the deduction is not prohibited by any of subsections 121(2.1, (2.2) and (2.4) of the Act;

(e)     to the extent that the paid-up capital of the share exceeds its cost to the shareholder, the excess will be included as business income of the recipient under subsection 9(1) of the Act;

(f)     Part IV tax will be applicable to the deemed dividend to the extent provided for in subsection 186(1) of the Act subject to the limitations and exceptions set out in subsection 186(1.1) and sections 186.1 and 186.2 of the Act; and

(g)     the adjustment to proceeds of disposition under paragraph 54(h)(x) of the Act is irrelevant (because that provision is only relevant for the purposes of subdivision c of Division B of Part I of Act) and, as the Act provides no similar adjustment to proceeds of disposition or cost for the purpose of computing the gain or loss of the shareholder in these circumstances, any deemed dividend arising under subsection 84(3) of the Act on the redemption of shares held as inventory cannot affect or result in any loss being realized by the shareholder as a result of the redemption.

M.A. Hiltz for Director GeneralSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch