What are stock splits and stock consolidations?
A stock split is where a corporation exchanges one share of the corporation for multiple shares of the corporation. For example, the corporation may do a 2-for-1 stock split and exchange 50 outstanding shares of the corporation for 100 shares of the corporation. A stock consolidation or reverse stock split describes the inverse situation to a stock split – i.e. exchanging 100 outstanding shares of the corporation for 50 shares. The stock split or consolidation applies to all shareholders of the impacted class or classes of shares.
Generally, stock splits and consolidations are done by public corporations to impact share price. If a corporation’s shares were trading at $1,000/share, then after the stock split described above, those shares would be worth $500/share and therefore more affordable for investors. Stock splits and consolidations typically involve the shares being exchanged for the same class of shares meaning there is no change of the rights of the shareholders holding those shares.
Taxation of stock splits and consolidations
A stock split or consolidation is not a taxable transaction because no acquisition or disposition is said to have occurred. However, per the Canada Revenue Agency’s archived publication IT-6, this assumes all shareholders holding the class of shares receive the same proportion of shares from the stock consolidation or split and “there is no change in the total capital represented by the issue, there is no change in the interest, rights or privileges of the shareholders and there are no concurrent changes in the capital structure of the corporation or the rights and privileges of other shareholders.”
If the corporation does not use the same proportion of shares across all shareholders holding a particular class of shares, or changes the rights and privileges of the shareholders, a stock dividend or acquisition may have occurred. The shareholders will be seen to have either received new shares from the corporation, known as a stock dividend, or for the corporation to have acquired their outstanding stock. In either case, there would be a taxable event.
Adjusted Cost Base – The Relevance of Stock Splits and Stock Consolidations
Though a stock split or stock consolidation is not normally taxable event, the adjusted cost base of the shares is impacted. The adjusted cost base of the shares prior to the split or consolidation will be spread evenly across the shares after the split or consolidation. For example, Brad acquires 100 shares of Tax Lawyer Co. for $200 in 2018. His adjusted cost base per share is $2/share. In 2020, Tax Lawyer Co. does a stock split and exchanges Brad’s 100 shares for 200 shares. Brad’s shares now have an adjusted cost base of $1/share. His total adjusted cost base for what are now 200 shares remains at $200.
The change in adjusted cost base may impact the capital gain or loss reported by the shareholder upon disposition of the shares. This is because capital gains and losses are 50% of the difference between the disposition price and adjusted cost base of the shares. Returning to our example of Brad above, if Brad sells his shares of Tax Lawyer Co. for $4/share in 2022, Brad would have a capital gain of $1.5 per share ( 50% of $4 minus $1). If the stock split had never occurred, Brad’s capital gain would be only $1 per share (50% of $4 minus $2) assuming that there was no difference in stock price pre-and post split. Typically the stock price will change as a result of the split. In this case, Brad’s after-tax income from the sale of the shares is higher if the stock split occurs even though he has a larger capital gain.
T1134 – Foreign Affiliate Reporting
In limited cases, a stock split or stock consolidation may impact a taxpayer’s T1134 filing requirements. The T1134 form requires Canadian resident taxpayers to report to the CRA, with certain exceptions, their foreign affiliate corporations. A corporation outside Canada is a foreign affiliate of a resident taxpayer if:
- The taxpayer’s equity percentage in the corporation is 1% or greater; and
- The equity percentages of the taxpayer and each “person” related to the taxpayer total to 10% or greater.
A stock split or stock consolidation may change the equity percentage ownership of the taxpayer, or related persons and either create or remove a T1134 reporting requirement. In particular, this change in reporting requirements may arise where the stock split or consolidation applies only to one of several class of shares issued by the corporation. For more on the T1134, see our article T1134 Canadian Income Tax Form.
Pro Tax Tips: Stock Dividends are Taxable
Briefly mentioned above was stock dividends. Stock dividends occur where the corporation issues additional shares of itself to existing shareholders. Stock dividends are often done to decrease the value of the corporation’s shares. The receipt of stock dividends is a taxable transaction for shareholders, as is the eventual disposition of those shares. The Canada Revenue Agency may closely analyze the terms and circumstances of a stock split to identify whether what occurred was a stock split, as claimed, or was actually a stock dividend. If you’re unsure if a corporation is issuing you a stock dividend or you are part of a stock split, or if the Canada Revenue Agency disputes your reporting of a stock split, our experienced Canadian tax lawyers can assist in identify the correct reporting and defending it against the Canada Revenue Agency.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."