Paid-up capital (PUC) is a tax concept, tracked by the corporation itself for each class of shares under section 89(1) of the Income Tax Act, and it is what decides how much a corporation can pay a shareholder on a redemption or capital reduction before any part of the payment becomes a deemed dividend.
Section 89(1) starts PUC from ordinary corporate-law stated capital, then overrides it with a list of the Income Tax Act’s own anti-avoidance sections — sections 84.1, 84.2 and 212.3 among them — that can grind it down in non-arm’s-length reorganisations. It is a corporate, per-class number, which is the opposite of adjusted cost base: personal, per-shareholder, and tracking what each individual actually paid. The two numbers routinely diverge, and only one of them limits a tax-free return of capital.
For a fund, this shows up directly in rollover equity. Shares issued to a founder or continuing manager in the acquisition vehicle usually carry PUC tied to their subscription price or, on a section 85(1) rollover, to figures set by that election — not to the deal value the shares actually represent. One Ontario firm’s own worked example makes the point with two shareholders of identical shares: a distribution within the corporation’s total PUC returns capital tax-free to both; anything paid above it becomes a deemed dividend to both, regardless of what either shareholder individually paid.
A founder’s original common shares carried $100 of paid-up capital. On a section 85(1) rollover into the fund’s newco, the founder receives preferred shares with a $2,000,000 fair market value; because the reorganisation is not caught by section 84.1’s grind on these facts, PUC generally carries over from the old shares rather than stepping up to the elected amount — so the founder ends up holding $2,000,000-value preferred shares with only $100 of paid-up capital. Nearly the entire eventual redemption proceeds will be a deemed dividend, not a capital gain, unless the structure accounts for that gap in advance.
See also: Deemed dividend · Adjusted cost base · Estate freeze.
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