CAPITAL DIVIDEND ACCOUNT (FOR TAX-FREE DIVIDENDS)
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A private corporation’s Capital Dividend Account is the means by which the corporation pays its resident-Canadian shareholders tax-free capital dividends. The Capital Dividend Account (CDA) does not appear on a balance sheet, although it might appear in the notes of a financial statement, where the accountants are sufficiently apprised as to the inner workings and transactions of the corporation.
However, where the accountants and the lawyers are not made privy to what is transpiring in the private corporation’s Capital Dividend Account, oftentimes, because the principals of the corporation (its officers, directors, and shareholders) are not aware of the tax advantages available through recording and using a Capital Dividend Account, the shareholders are unable to take advantage of tax-free capital dividends.
And what is this particular tax advantage, it is the ability for the shareholders to withdraw the corporation’s money (that is in the Capital Dividend Account) without paying any taxes. You heard that correctly, this is not an error or an oversight on the part of Revenue Canada, but instead a feature of the Income Tax Act and its objective of realizing a major tax principle, namely Integration. Nevertheless, to take advantage of this corporate tax practice, it is necessary to record and maintain a Capital Dividend Account, which accumulates those tax-free amounts at the corporate level for subsequent tax-free distribution to the shareholders as a capital dividend.
The most common tax-free amounts included in the private corporation’s Capital Dividend Account are:
• the tax-free portion of capital gains realized by the corporation to the extent they exceed the non-deductible portion of the corporation’s capital losses;
• capital dividends received from other corporations [that made an election under subsection 83(2) of the Income Tax Act];
• eligible capital amounts, being the non-taxable portion of capital gains realized on the disposition of a capital property, including a depreciable property under Class 14.1 of Schedule II of the Regulations; and
• life insurance proceeds on certain policies received as a consequence of the death of a person. Because the Capital Dividend Account is a running balance account, capital dividends paid by the private corporation to its Canadian-resident shareholders will reduce the account balance.
The capital dividend may be paid in cash, in specie (satisfied by a transfer of assets) or as a stock dividend. The significance of properly recording and maintaining a Capital Dividend Account, and paying the corporation’s shareholders with capital dividends to the extent available, cannot be overstated. Where there is the availability of tax-free dividend distributions to the corporation’s shareholders, the shareholders should be looking to optimize this opportunity, as opposed to allowing it to go to waste .
For a private corporation to pay a capital dividend, it must make an election to designate the entire amount of the dividend to be a capital dividend, and file Form T2054, Election for a Capital Dividend Under Subsection 83(2) with the CRA, together with other applicable documentation. Further specifics as to capital dividends and capital dividend accounts is set out in Revenue Canada’s Income Tax Folio S3-F2-C1.
For corporate tax matters and advanced tax planning, including optimizing legitimate tax planning strategies to get the most from your business, contact our law firm to schedule a confidential initial consultation at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.
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