Dividend Income: Preferred shares will pay you dividends, (typically on a quarterly basis) which will qualify for the dividend income tax credit. The amount of eligible dividend income you have received, and must pay income tax on, is reported annually in a T5 Income tax Information Slip sent at the end of each calendar year by the financial institution where you hold the preferred shares.
Taxable Capital Gains/Losses: When you sell a preferred share investment you will create one of the following taxable events.
Taxation Upon Redemption/Retraction: If your preferred shares are purchased from you by the issuing company under a Redemption Notice or your decide to exercise your right to sell under a Retraction feature, you should be aware of the potential income tax implications. How your investment is taxed upon Redemption or Retraction will depend upon the “Paid Up Capital”, or PUC, amount assigned to each share by the issuing corporation. Most preferred shares have a PUC equal to the share’s original issue price or Par Value – typically $25.00. But in instances where the company has gone through a reorganization or acquisition, the PUC amount may be different and that difference will impact the income tax you pay.
For example, let’s say the shares that you originally purchased for $25.00 each are to be redeemed by the company at $26. And you know the share’s PUC amount, assigned by the company, is $25. Then upon redemption, the $1.00 difference between the PUC amount of $25 and the redemption price of $26.00 will be taxed as a Deemed Dividend.
If, however, the PUC amount is different, then you may have a larger or smaller Deemed Dividend plus a Taxable Capital Gain or Loss.
Let’s look at a real-life example – the redemption of the Series O preferred shares issued by Great-West Life Assurance in 2010. (Note: The Series O shares were the result of Great-West Life’s purchase of London Life some years before.)
Let’s say you purchased your shares for $25.00 each and you received a redemption notice saying the company is buying back your shares for $25.00 each and the shares currently trade at $25 in the stock market. (No problem – you paid $25 and you are getting back $25 – Right!) Unfortunately, as a result of the company’s reorganization with Great-West Life, the shares actually have a Paid Up Capital Value equal to $17.26 per share, not the $25.00 you paid.
As a result, if you hold the shares until they are redeemed, you will receive $25 per share in cash, but from an income tax perspective, the $17.26 will be deemed as your cost or book value and the difference of $7.74 will be deemed as a Taxable Dividend.
In this scenario, you would be better to sell the shares before the redemption date. In the able below this transaction is summarized.
|Implications of Preferred Share Redemption|
|Redemption||Versus||Sale in Market|
|Less Paid Up Capital:||$17.26|
|Deemed Dividend Income Per Share:||$7.74|
|Paid Up Capital Per Share:||$17.26|
|Less: Your Cost Per Share:||$25.00||$25.00|
|Capital Gain (Loss):||($7.74)||$0.00|
Now assume you actually owned 1,000 shares, then holding the shares until their redemption would result is a Capital Loss of $7,740 and a Taxable Deemed Dividend of $7,740. Ouch!
So in this real-life example, on an after tax basis, it would have been better to selling the shares prior the redemption date.
The calculations are the same for investors exercising a share’s Retraction feature.
Important Note: When faced with a Redemption or Retraction decision, we recommend investors seek appropriate income tax advice from a qualified income tax professional. Our discussion above is for educational purpose only and should not be interpreted as income tax advice.