Written by Zach Kennedy
JD Candidate 2024 | UCalgary Law

In the unpredictable entrepreneurship landscape, not every startup embarks on a journey to success. Amidst the exhilarating pursuit of innovation, founders must also prepare for possible setbacks and losses. Effective tax planning emerges as a crucial strategy in this context, offering founders avenues to mitigate potential financial losses. By strategically navigating tax regulations, founders can safeguard their assets, optimize deductions, and minimize tax liabilities, even in the face of business challenges. Section 88(2) of the Income Tax Act (“ITA”) is one of those tax planning tools that can assist in minimizing the possible tax consequences for founders who wish to wind up their operations. "Winding-up" is used in connection with the winding-up of a business and the winding-up of a corporation's existence, whether voluntary or otherwise.[1]

Imagine Bill having started such a business; as it stands the total value of the corporation's assets is $100,000, but Bill just doesn’t see a future for the business, so they wish to wind it up. Bill is the sole shareholder. In winding it up, Bill decides that they will just take back the assets from the corporation and begin winding it down. A few different things might happen to those amounts distributed back to them.

1. The amount might be a s.15 Shareholder Benefit;
2. The amount might be seen as a taxable dividend under s.84(2);
3. The amount might be seen as a taxable dividend under s.84(2), but it will be considered a wind-up under s.88(2).

 
Possible Dangers of S.15

S.15 states that at any time a benefit is conferred by a corporation on a shareholder, the amount or value of the benefit is included in the shareholder's income.[2] In this case, the $100,000 of assets might simply be included back into Bill’s income, as they consist of a benefit given to them. This can represent a massive tax liability on wind-up, as the assets that may have been transferred into the corporation by the founder (who may be the sole shareholder) would be transferred back to them as a shareholder benefit. Their whole value would be taxed back as regular income. Based on top rates in Alberta, that might result in an additional $48,000 in taxes to be paid.[3]

Deemed Dividends on Windup per S.84(2)

Luckily, s.15 makes an exception and excludes the amounts which are deemed dividends by operation of s.84.[4] However, The language in both s.15(1) and s.84 are substantially similar – both referencing distributions for the benefit of the shareholder – it must be clear where one is operating within the ITA. Subsection 84(2) applies to either the winding-up of a business or the winding-up of a corporation.[5]

On a typical wind-up of a corporation’s business, the assets in a corporation are distributed back out to the shareholders by way of deemed dividend per s.84(2). A dividend paid on a winding-up will be taxable, and such an amount must be included in the shareholder’s income.[6] This differs from s.15 in that it allows for a reduction of the value of the property distributed by the amount of the paid-up capital of the shares. This can be directly contrasted with how s.15 treats these distributions. For example, if Bill originally paid $50,000 for their shares of the corporation (and took nothing back but shares) then the shares would have a paid-up capital equal to $50,000. On the operation of s.84(2), the amount of the deemed dividend would reduce by $50,000, resulting in an income inclusion of only $50,000; half of what would be included under s.15.

Easing of Taxation Under s.88(2)

Finally, it may be the case that s.88(2) applies. Section 88(2) only applies where the appropriate corporate procedures are followed to bring a corporation's existence to an end.[7] Specifically, S.88(2) applies where a Canadian corporation is wound up after 1978, and throughout the winding-up, all or substantially all of the property owned by the corporation immediately before that time was distributed to the shareholders of the corporation.[8] The main benefit of s.88(2) applying is that it ensures that a corporation’s “capital dividend account,” “capital gains dividend account,” and “pre-1972 capital surplus on hand” reflect the disposition of funds or property by the corporation on the winding-up.[9]

By giving access to accounts like the Capital Dividend Account (CDA), a reduction in the total amount of taxable dividends (and consequently taxable liability) can be reduced. Specifically, s. S.88(2)(a) allows the inclusion of any capital gains existing before the final distribution in the CDA.[10] The amounts in the CDA can then be declared as capital dividends and are excluded from the recipient's income.[11]For example, if a property in the corporation realized a capital gain of $25,000, half of that amount could be added to the CDA and distributed as a capital dividend. This would result in $12,500 being distributed out to Bill tax-free.

Conclusion

Navigating the intricacies of tax law, particularly concerning sections 88(2), s.84(2) and s.15 of the Income Tax Act, requires a nuanced understanding of applicable provisions and careful strategic planning. For any wind-up to avail oneself of the benefits under s.88(2), they may wish to take care to ensure that proper formalities are observed (such as director’s resolutions with very clear minutes) to provide evidence that a wind-up is being performed. If this isn’t done, then it may be the case that s.15 shareholder benefit provision may apply, which will result in the complete inclusion of the fair market value of the assets into taxable income. Businesses can optimize their tax positions and minimize exposure to unintended tax liabilities by leveraging the benefits of s.88(2) on wind-up while implementing prudent measures to mitigate shareholder benefits under s.15.


[1] Canada Revenue Agency (CRA), Interpretation Bulletin IT-126R2 – Meaning of “Winding Up”

[2] Income Tax Act, RSC 1985, c 1 (5th Supp), s.15(1).

[3] Canada Revenue Agency (CRA). (2024, January 23). Income tax rates for individuals. https://www.canada.ca/en/revenue-agency/services/tax/individuals/frequently-asked-questions-individuals/canadian-income-tax-rates-individuals-current-previous-years.html

[4] Income Tax Act, RSC 1985, c 1 (5th Supp), s.15(1)

[5] Supra note 3.

[6] Income Tax Act, RSC 1985, c 1 (5th Supp), s.84(2)

[7] Canada Revenue Agency (CRA), Interpretation Bulletin IT-126R2 – Meaning of “Winding Up”

[8] Income Tax Act, RSC 1985, c 1 (5th Supp), s.88(2)

[9] Canada Revenue Agency (CRA), Interpretation Bulletin IT-126R2 – Meaning of “Winding Up”

[10] Income Tax Act, RSC 1985, c 1 (5th Supp), 88(2)(a)

[11] Income Tax Act, RSC 1985, c 1 (5th Supp), 83(2)(b)
 

Written by Emily Zheng
JD Candidate 2024 | UCalgary Law

Whether you are a partner in a partnership or a director of a corporation, there are duties that you owe to your fellow partners or directors that tend to go unspoken and unwritten during the lifetime of a business. Yet, breaching these duties can lead to a partner or a director being held liable to the other partners or the corporation respectively and subject to damages, disgorgement of profits, or other relief.
Duties Owed Between Partners in a Partnership
According to Section 6 of the Alberta Partnership Act,[1] partners within the same partnership are agents of each other, meaning they have given each other the power to affect their legal relationships.[2] Courts have identified two main categories of duties that an agent owes to their “principal”:[3]

1. Duty of care – this means agents must act with the care, competence, and diligence expected of agents in like circumstances, and they are obligated to follow all lawful and reasonable instructions from their principal.[4] Their duties must be carried out with reasonable diligence, and what is reasonable will depend on the circumstances of each case.[5]
2. Fiduciary duties – otherwise known as “duties of loyalty”- require an agent to keep their principal’s interests foremost in mind when completing assigned matters.[6] These duties include acting with perfect good faith and fully disclosing any information that may conflict with their principal’s interest.[7] Additionally, an agent cannot enter any transactions that may conflict with their principal’s interest unless the exact nature and extent of their interest is disclosed and the principal consents.[8]

The duties above are recognized by the courts and incorporated into the Alberta Partnership Act within Sections 22-35.
Duties Owed by Directors to Corporations
You can find almost identical duties listed above within the Alberta Business Corporations Act[9] in Section 122(1). However, courts have elaborated upon these duties within the context of corporations, expanding certain interpretations.

1. Duty of care – the Alberta Business Corporations Act states that directors are “to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”[10] This duty is applied broadly and can include individuals outside the corporation, such as creditors – however, the exact scope is still unclear. However, courts have acknowledged that this duty of care is a higher standard than the common law duty found between individuals.[11]
2. Fiduciary duties – similar to the elements mentioned above, directors have a duty to act honestly, in good faith, and in the corporation's best interests.[12] Since this duty is owed to the corporation (a separate legal entity), it includes all of the corporation’s stakeholders and is owed to them equally.[13] However, this duty was also found to be extendable to employees, creditors, consumers, governments, and even the environment.[14]

One difference to note between the duties owed between partners and those owed by directors to corporations is that, unlike partners, directors cannot take an opportunity that a corporation might accept without giving notice or approval to the corporation because this would provide directors with an unfair business advantage and is contrary to good faith.[15] Unlike partners, this duty does not end even after the business relationship ends.[16]
Conclusion
Similar to how good business practices often go unspoken, there are also underlying legal standards that courts expect business individuals to follow regardless of whether or not they are found on paper. While these duties are often missing from documents, courts still expect these statutory requirements and expectations to be met. 


[1] Partnership Act, RSA 2000, c P-3 [APA].

[2] Swift v Tomecek Roney Little & Associate Ltd, 2014 ABCA 49.

[3] Watson v Holyoake, [1986] OJ No 541 [Watson].

[4] Ibid.

[5] Groom, Lecky, Noonan v MacFarlane, 2000 PESCTD 61 at para 15.

[6] APA, supra note 1.

[7] Watson, supra note 3.

[8] Ibid.

[9] Business Corporations Act, RSA 2000, c B-9.

[10] Ibid, s 122(1)(b).

[11] Peoples Department Stores Inc (Trustee of) v Wise, 2004 SCC 68.

[12] Ibid.

[13] BCE Inc v 1976 Debentureholders, 2008 SCC 69.

[14] Ibid.

[15] Canadian Aero Service Ltd v O’Malley et al, [1974] SCR 592.

[16] Ibid.

Written by Kyle Murdy
JD Candidate 2025 | UCalgary Law


The decision between bringing someone into a business as an employee or an independent contractor has both benefits and consequences in terms of their exit from the business. First, the factors that differentiate an employee from an independent contractor must be considered. To do this, the factors from the Sagaz test will be considered (1). These are listed below:

1. Control: The more control the employer has, the more likely this is going to be seen as an employer-employee relationship. Does the worker decide when to work? Can the worker take breaks when he or she wants to? If yes, the worker is more likely an independent contractor. Does the employer provide training, quality assurance, and performance evaluations? If yes, the worker is more likely an employee. Are there standards and expectations set up but no day-to-day control? Less day-to-day control results in the worker to more likely be seen as an independent contractor.
   
2. Equipment: Does the worker provide his or her own equipment? Does the worker have the ability to hire other people to help them? If yes the worker is more likely an independent contractor.
   
3. Financial Risk: What is the degree of financial risk the worker carries? Does the worker have the ability to make more money or less money? Do their actions change theireconomicoutcome? Ifyes,theworkerismorelikelyanindependentcontractor. If there is no meaningful opportunity to profit then the worker is more likely an employee. If the worker has an ability to determine their profit or loss margin, they are more likely an independent contractor.
   
4. Responsibility: What is the degree of responsibility for investment and management held by the worker? Is the worker in charge of their own work schedule by accepting or rejecting jobs? If yes, the worker is more likely an independent contractor.
   

One difference between the two to consider for businesses adding personnel is what occurs when an employee is to be terminated. When an employee is terminated by a business, the company will be found liable for unpaid taxes, EI, and CPP contributions. In certain cases, severance payments will also be required. Independent contractors are very different, as their termination provisions are typically governed by the terms of their independent contractor agreement. They will not typically receive the benefits described above that employees receive unless these are explicitly provided for in the terms of their contractor agreement. Companies
instead may terminate these independent contractors when a material breach of their agreement occurs - and this breach must be substantial enough to defeat the purpose of the contract

1. 671122 Ontario Ltd v Sagaz Industries Canada Inc, 2001 SCC 59, [2001] 2 SCR 983.