CAPITAL DIVIDENDS (TAX-FREE DIVIDENDS)
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Capital dividends are private corporation dividends that are paid tax-free to their Canadian-resident shareholders, such that no part of the dividend is included in computing the recipient shareholder’s taxable income. The election to pay capital dividends to its shareholders pursuant to subsection 83(2) of the Income Tax Act is only available to private corporations, as defined in subsection 89(1) of the Income Tax Act, with public corporations being specifically excluded from electing to pay capital dividends.
A capital dividend is paid from the private corporation’s Capital Dividend Account (CDA), which is an account that tracks various tax-free amounts that have been accumulated by the private corporation. 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.
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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