What happens when the shareholders no longer need a corporation? A corporation is legally required to file a final T2 income tax returns along with filing annual reports with the registrar of companies as long as it is in existence, regardless of whether it is active or not. In order to stop filing tax returns, the corporation must be dissolved or wound up. The formal procedure for dissolving a corporation involves filing forms with the registrar of companies for the jurisdiction in which the company was incorporated, and filing a final T2 tax return.
In Alberta, if the corporation simply ceases to file annual reports with the registrar of companies, it will eventually be removed from the corporate registry. At that point, it is deemed to be dissolved under the Income Tax Act. This approach, while simple and easy, can have adverse tax consequences. It is best to voluntarily dissolve your corporation, not have it involuntarily dissolved.
When a corporation is dissolved, either voluntarily or involuntarily, the income tax act deems that the shareholders have received a dividend. This dividend is equal to the fair market value of the assets transferred to the shareholders of the corporation, less the paid up capital of the shares. However, there is an election available under the income tax act that allows a tax free capital dividend to be paid, if the corporation has a balance in its capital dividend account. The capital dividend reduces the taxable dividend on windup, if the proper forms are filed prior to the capital dividend being paid out. The forms cannot be filed late, so if the corporation is struck from the corporate registry, the entire dividend will be taxable, and any capital dividends will expire unused.
The tax consequence of the windup is that the corporation is deemed to have disposed of all assets at fair market value. The result can be a capital gain or loss, recapture of Capital Cost Allowance or a terminal loss, depending on the nature of the assets. This can have significant tax consequences if the windup is not planned properly. Real estate in particular can cause significant issues problems, especially when it comes to the value of land. If land is worth considerably more than the cost, a large taxable capital gain may result on the windup, which the corporation would be responsible for. If the land is transferred to the shareholder and not sold, there may not be sufficient cash in the corporation to pay the taxes due.
Successful planning for the windup may include using a holding company to receive the winding up dividend, which would then be tax free, or transferring the assets of the corporation being wound up to another corporation using Section 85 of the Income Tax Act in order to avoid triggering a capital gain or recapture of CCA.
If you are considering winding up a corporation that is no longer being used, talk to us at Jibe Accounting, your Calgary Tax Accountant, we will ensure you are taking advantage of the opportunities to defer or eliminate tax available in the Income Tax Act.