Surplus stripping describes arrangements that seek to extract a corporation's retained earnings as a lower-taxed capital gain or a return of capital rather than as a dividend. The principal anti-avoidance rule aimed at it is section 84.1 of the Income Tax Act, which applies to certain non-arm's-length transfers of shares.
Where section 84.1 applies, it can grind the paid-up capital of the shares received and deem some of the consideration to be a dividend, removing the intended advantage. The adjusted cost base used in the calculation is reduced by amounts previously sheltered by the lifetime capital gains exemption. A narrow exception exists for genuine intergenerational business transfers that meet strict technical conditions. The general anti-avoidance rule can also apply to more aggressive structures.