Winding Up a Canadian Corporation After You Have Moved to the US: The Final T2, the Deemed Dividend, and the US Liquidation

The ideal time to wind up a Canadian corporation is before the shareholder becomes a US person, when the capital dividend account can be paid tax-free and the liquidation is a Canadian event only. Many shareholders move first and decide later, and the wind-up then has two sides: a Canadian liquidation that produces a deemed dividend to a non-resident subject to Part XIII withholding, and a US liquidation that treats the distribution as a sale of the shares. The corporation is also a controlled foreign corporation for its final year, with a final Form 5471.

Key takeaways

• Canadian side: on winding up, the corporation is deemed to pay a dividend equal to the distribution in excess of the paid-up capital of the shares (section 84(2)); to a non-resident shareholder the dividend is subject to 25% Part XIII withholding, reduced to 15% under the treaty (5% if the shareholder is a US corporation owning 10% or more). The capital dividend account can still be paid tax-free in Canada, but a US-resident shareholder is taxed on it in the US.
• US side: the distribution is treated as full payment for the shares under section 331; the shareholder's gain is the amount received less the US basis in the shares (stepped up to the departure-date value if the Article XIII(7) election was made), taxed as capital gain, with a foreign tax credit for the Canadian withholding. The dividend characterization in Canada and the capital gain characterization in the US do not align, and the credit is computed on the US gain.
• Form 5471: the corporation is a CFC through the liquidation; a final Form 5471 reports the year, and any Subpart F or tested income for the final period is included.
• Sequence: collect receivables, sell assets (Canadian tax on corporate gains), pay liabilities, file the final T2 and GST/HST returns, distribute, apply for a clearance certificate, dissolve under corporate law, close the CRA accounts.
• Better sequence: all of the above before the departure date, while the shareholder is a Canadian resident.

Before departure versus after

Before. The shareholder is a Canadian resident. The capital dividend account (the tax-free half of capital gains realized by the corporation, plus life insurance proceeds) is paid as a tax-free capital dividend on an election. The remaining surplus is paid as a taxable dividend at Canadian dividend rates (about 39% to 48% at the top depending on eligibility and province), or the shares are deemed sold on departure at fair market value with half the gain taxable. No US involvement. The corporation is dissolved before the shareholder becomes a US person; no Form 5471 ever.

After. The shareholder is a US resident. The CDA can still be paid, but it is US-taxable to the shareholder as part of the liquidation proceeds. The deemed dividend under section 84(2) is subject to 15% treaty withholding; the shareholder files no Canadian return for it (Part XIII is final). In the US, the entire distribution is treated as proceeds of a sale of the shares; the gain is the proceeds less basis, and the basis was stepped up to fair market value on the departure date if the XIII(7) election was made on the first US return. If the corporation's value has not changed since departure, the US gain is small; the Canadian withholding on the deemed dividend is a foreign tax credit in the passive basket, limited to the US tax on that gain, and often partly stranded.

The Canadian mechanics

1. Convert assets to cash or distribute in kind (distributions in kind are deemed dispositions at fair market value by the corporation, with corporate tax on any gains).
2. Pay or provide for liabilities, including the final corporate tax.
3. File the final T2 (and provincial return in Quebec or Alberta) for the period ending on the wind-up, and the final GST/HST return.
4. Pay the capital dividend (election on Form T2054) and the deemed dividend on the balance; withhold Part XIII on the deemed dividend to the non-resident shareholder at the treaty rate (NR301 on file) and remit on Form NR4.
5. Apply for a clearance certificate (Form TX19 for the corporation) before final distribution.
6. Dissolve under the CBCA or provincial statute (articles of dissolution) and close the business number and program accounts.

The US mechanics

1. Report the liquidation on the shareholder's 1040: proceeds (all distributions, including the CDA, in US dollars) less basis (the departure-date value under the XIII(7) election, or historical cost if no election), as capital gain on Schedule D.
2. Claim the Canadian withholding as a foreign tax credit on Form 1116, passive basket.
3. File the final Form 5471 for the corporation's last year, reporting the liquidation on Schedule O, and any Subpart F income for the final period.
4. If the corporation had earnings and profits and was a CFC, consider whether any portion of the distribution is a dividend under section 1248 (recharacterizing gain as dividend to the extent of E&P accumulated while a CFC), which affects the rate and the credit.

Worked example

A Toronto consultant with a professional corporation holding $500,000 of cash and investments (paid-up capital $100, CDA $60,000) moved to Florida on June 30 and decides to wind up the corporation the following year, when it is worth $520,000.

• Departure. The shares were deemed sold on June 30 at $500,000; Canadian departure tax on the gain; XIII(7) election on the first US return steps up US basis to $500,000.
• Canadian wind-up. CDA of $60,000 paid tax-free in Canada; deemed dividend of about $460,000 to a non-resident; 15% treaty withholding, $69,000; no Canadian return.
• US. Proceeds $520,000 less basis $500,000: $20,000 capital gain, roughly $4,000 of US tax; the $69,000 Canadian withholding is a foreign tax credit limited to the US tax on the gain; about $65,000 of credit is stranded in the passive basket.
• Better path. Wind up before June 30: CDA tax-free, $440,000 taxable dividend at Canadian rates (roughly $190,000), no departure tax on the shares (already distributed), no US involvement, no stranded credit. Total Canadian tax roughly $190,000 versus roughly $135,000 departure tax plus $69,000 withholding plus $4,000 US tax after the move, with $65,000 of credit lost.

Official sources

"Once the corporation has been dissolved, you should consult Form RC145, Request to Close Business Number Program Accounts, to determine whether you need to fill in that form and send a copy of the articles of dissolution to the CRA. Otherwise, the CRA considers that the corporation still exists and it will have to file a return even if there is no tax payable." — Canada Revenue Agency, Closing accounts, https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/changes-your-business/closing-accounts.html

"Liquidating distributions, sometimes called liquidating dividends, are distributions you receive during a partial or complete liquidation of a corporation." — Internal Revenue Service, Publication 550, Investment Income and Expenses, https://www.irs.gov/publications/p550

"Certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations file Form 5471 and schedules to satisfy the reporting requirements of sections 6038 and 6046, and the related regulations." — Internal Revenue Service, About Form 5471, https://www.irs.gov/forms-pubs/about-form-5471

Practitioner note

The post-departure wind-up produces a Canadian dividend and a US capital gain on the same distribution, and the foreign tax credit cannot reconcile them because the US gain after the basis step-up is small. The withholding is a permanent cost. We wind up before the departure date whenever the timeline allows, and when it does not, we model the stranded credit before the client decides.

See also: Planning a move? Start with the Canada-to-US tax checklist and browse every corridor by city, province, and state.

Next step

Fairlight prepares the pre-departure wind-up where the timeline allows, or the post-departure liquidation on both sides with the final T2, the Part XIII withholding, the section 331 reporting, and the final Form 5471. See cross-border pricing or book a call.