Double taxation on dividends in the context of Canadian estate planning—especially when a deceased individual owns private company shares—is a well-known issue that can significantly reduce the value passed on to beneficiaries. Here's a clear breakdown of how it happens and how it can be mitigated: 

⚠️ What Is Double Taxation? 

Double taxation occurs when two separate layers of tax are applied to the same underlying value of private company shares after the owner's death: 

1. Capital Gains Tax at Death 

Upon death, the deceased is deemed to have disposed of all capital property (including private company shares) at fair market value (FMV).

This triggers a capital gain if the shares have appreciated, and the estate pays tax on that gain.

2. Dividend Tax on Distribution 

Later, when the corporation distributes its assets (e.g., cash or property) to the estate or beneficiaries, those distributions are treated as taxable dividends.

This results in a second layer of tax, even though the estate already paid tax on the same value via the deemed capital gain.

📉 Example of Double Taxation 

Let’s say: 

The deceased owned shares in a private company worth $5 million.

The shares had a nominal cost base (e.g., $1).

Tax Layer 1: Capital Gains 

Deemed disposition at death: $5 million

Capital gain: $4,999,999

Tax on capital gain (approx. 25%): $1.25 million

Tax Layer 2: Dividend Distribution 

Corporation pays out $5 million to the estate as dividends.

Tax on dividends (approx. 45%): $2.25 million

Total tax paid: $3.5 million, or 70% of the estate value. 

🛡️ How to Avoid Double Taxation 

✅ Post-Mortem Pipeline Planning 

The estate transfers shares to a new corporation (NewCo) in exchange for a promissory note.

The operating company (Opco) pays intercorporate dividends to NewCo.

NewCo repays the promissory note to the estate as a return of capital, not a taxable dividend.

This avoids the second layer of tax and is CRA-approved if done properly.

✅ Loss Carryback Planning 

If the corporation is wound up, the estate may realize a capital loss on the shares.

This loss can be carried back to offset the capital gain reported at death, reducing the overall tax burden.

📌 Key Considerations 

Timing matters: CRA expects a delay (12–24 months) between death and pipeline transactions to avoid anti-avoidance scrutiny.

Economic substance: The companies involved must remain active or have a valid business purpose.

Professional guidance: These strategies are complex and require coordination between tax advisors, lawyers, and accountants.

Here’s a detailed explanation of how a pipeline plan works in Canadian estate planning, the role of a promissory note, and the capital loss carryback rules that help mitigate double taxation: 

🏗️ What Is a Pipeline Plan? 

A pipeline plan is a post-mortem tax strategy used to avoid double taxation when a shareholder of a private corporation dies. 

⚠️ The Problem: 

On death, the deceased is deemed to have disposed of their shares at fair market value, triggering a capital gain.

Later, when the corporation distributes its assets to the estate, it may be taxed again as a dividend.

✅ The Pipeline Solution: 

To avoid this double tax, the estate can implement a pipeline plan: 

Transfer of Shares: The estate transfers the deceased’s shares to a new corporation (NewCo) in exchange for a promissory note.

Dividend Flow: The original operating company (Opco) pays intercorporate dividends to NewCo.

Repayment: NewCo uses those dividends to repay the promissory note to the estate.

Tax Benefit: The repayment is treated as a return of capital, not a taxable dividend, avoiding the second layer of tax.

📜 What Is a Promissory Note in This Context? 

In a pipeline plan, a promissory note is a legal instrument representing the amount NewCo owes to the estate for the transferred shares. 

It allows the estate to receive funds over time.

The CRA expects commercially reasonable terms, including:

A 12–24 month delay before repayment begins.

Economic substance: Both Opco and NewCo should remain active.

📉 Capital Loss Carryback Rules (Subsection 164(6)) 

These rules allow an estate to carry back capital losses to offset the deceased’s capital gains in their final tax return. 

🔁 How It Works: 

If the estate redeems shares and incurs a capital loss, it can elect to apply that loss to the deceased’s terminal return.

This offsets the capital gain from the deemed disposition at death.

🕒 Timing Matters: 

Traditionally, the loss had to occur in the first taxation year of the estate.

As of August 2024, the rule was expanded: the loss can now be realized within three years of death and still be carried back.

🧾 Example: 

Deceased owns shares worth $500,000 with an ACB of $1,000.

On death: deemed capital gain of $499,000.

Estate redeems shares: deemed dividend of $499,000 and a capital loss of $499,000.

The estate elects to carry back the loss, eliminating the capital gain on the deceased’s final return.

Disclaimer:

The content on this website is provided for general informational purposes only and does not constitute legal or professional advice. Visitors are encouraged to seek specific legal guidance by contacting the lawyers at CRS Law Collective or their own legal counsel regarding any particular matter. CRS Law Collective does not guarantee the accuracy, completeness, or currency of any information on this website. The materials published here are current as of their original publication date and should not be relied upon as accurate, complete, or applicable to any specific situation.

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