Use of a Trust for Cross-Border Surplus-Stripping

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The paid-up capital of the shares of a Canadian corporation generally represents the amount of capital that has been contributed to the corporation by its shareholders. The paid-up capital is a tax attribute because it can be returned to the shareholders free of tax. It is also included in the determination of a corporation's equity under the thin capitalization rules, which can increase the amount of its deductible interest expenses. The amounts distributed to the shareholders that exceed the paid-up capital are usually treated as taxable dividends. These dividends are subject to income tax if they are received by non-resident shareholders.

Certain non-resident individuals may obtain tax benefits through a transfer of the shares of one corporation resident in Canada to another such corporation (the “Canadian purchaser corporation”) with which they are not dealing at arm's length, in exchange for shares of the Canadian purchaser corporation or other forms of consideration.

The cross-border anti-surplus-stripping rule is intended to prevent non-residents from using deemed dividends or a reduction of paid-up capital to extract free of tax a corporation's surplus in excess of the paid-up capital of its shares, or to artificially increase the paid-up capital of such shares.

As of February 27, 2018, this rule applies to transactions involving a trust. The trust will have to allocate its assets, liabilities and transactions to its beneficiaries based on the relative fair market value of the beneficiaries' interests in the trust.

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