When shares are redeemed, the gain may consist of two components: a capital gain and a deemed dividend. The deemed dividend per share is calculated as the difference between the Redemption Price per share and the Paid Up Capital (PUC) per share. This deemed dividend may be tax-free when WUTIF transfers some of its Capital Dividend Account (CDA) to the redeemed shares. In this case, there would be no T5 issued.
There will also be a capital gain when shares are redeemed if the PUC/share is greater than the investor’s Adjusted Cost Base (ACB/share). But if the investor;s ACB/share is greater than the PUC/share, there’d only be a dividend which is tax-free.
For example, Investor X redeems his shares for $27.00. His ACB is $14.50 (this is the average price he paid for his shares). The $27.00 redemption price consists of a PUC/share of $19.86 and a deemed dividend of $7.14 per share.
In this case, the deemed dividend is $7.14 and the capital gain is $19.86-$14.50 = $5.36 per share. The investor pays no tax on the deemed dividend but would pay regular capital gains tax on the $5.36 per share.
The total that is taxed is $7.14+$5.36= $12.50 which is the gain based on the ACB except that this gain isn’t taxed at the capital gains rate – it’s taxed partly as a cap gain and partly as a dividend. However, WUTIF can, from time to time, transfer some of its Capital Dividend Account (CDA) to investors, eliminating the deemed dividend (and tax thereon) entirely! In this case the Investor in the above example would pay cap gains tax on just $5.36.
In the above example, suppose that the investor’s ACB is $20.00/share. In this case, the deemed dividend is $7.14 per share but there is no capital gain (because the ACB>PUC). No tax would be payable in this instance.