At the beginning of the current year, Shahbaz Inc., a CCPC, has shares with a PUC of $4,000,000, and a balance of $300,000 in its capital dividend account. The company was started by Mr. Sheikh, who made a $4,000,000 investment in the common shares. During the current year, the company has disposed of a major division, and it will distribute $1,000,000 to its sole shareholder, Mr. Sheikh. The company will reduce the PUC by $600,000 in order to minimize the tax consequences to Mr. Sheikh. What is the ACB of Mr. Sheikh's shares after this transaction is completed?

Question

Quizplus · Accepted Answer

The capital dividend account (CDA) is a notional account that tracks the tax-free portion of capital gains and life insurance proceeds that a corporation can pay out to its shareholders as capital dividends. When a CCPC pays a capital dividend, it reduces the corporation's CDA by the amount of the dividend. Capital dividends are tax-free to the recipient.

In this case, the company has $300,000 in its CDA and will pay a capital dividend of $1,000,000 to its sole shareholder, Mr. Sheikh. Since the company wants to minimize the tax consequences to Mr. Sheikh, it will reduce the PUC by $600,000 before paying the dividend. This means that the dividend will consist of $400,000 from the CDA and $600,000 from the reduction in PUC.

The ACB of Mr. Sheikh's shares will then be reduced by the amount of the capital dividend received, which is $1,000,000. Therefore, the ACB will be $3,400,000 ($4,000,000 original investment - $600,000 PUC reduction - $1,000,000 capital dividend). The correct answer is B.

At the Beginning of the Current Year, Shahbaz Inc