What is a Capital Dividend Account (CDA)?

A capital dividend is a type of dividend that a private Canadian corporation can pay to its shareholders on a tax-free basis. This is possible because capital dividends are drawn from the company's Capital Dividend Account (CDA), which tracks certain non-taxable income amounts such as the tax-free portion of capital gains and life insurance proceeds received by the corporation.

For shareholders, receiving a capital dividend means they do not have to pay personal income tax on the amount received, making it a highly tax-efficient way to extract funds from the corporation. However, it's important to note that the CDA itself is not a physical account but rather a tax account used for tracking purposes.

Key Components of a Capital Dividend Account (CDA)

The balance in a CDA typically includes the following amounts:

1. Capital Gains: The non-taxable portion of capital gains realized by the corporation (i.e., 50% of capital gains or 25% of capital gains after June 24th, 2024).

2. Capital Dividends Received: Capital dividends received from other corporations.

3. Life Insurance Proceeds: The excess of life insurance proceeds received by the corporation over the adjusted cost basis of the policy.

4. Capital Losses: The CDA balance is reduced by the non-deductible portion of capital losses incurred by the corporation.

How the CDA Works

Tax-Free Distributions:

A private corporation can elect to pay a capital dividend to its shareholders up to the balance available in the CDA. This dividend is tax-free for shareholders, making it an efficient way to extract funds from the corporation.

Election Process:

To pay a capital dividend, the corporation must file an election with the Canada Revenue Agency (CRA) using Form T2054, "Election for a Capital Dividend Under Subsection 83(2)." This form must be filed by the first day the dividend is paid. One completed copy of the election must be filed separately from any tax return. Form T2054 must be accompanied by a certified copy of the resolution of the directors of the corporation authorizing the election to be made.

Why is the CDA Important?

The CDA provides a significant tax advantage, allowing shareholders to receive dividends on a tax-free basis.

Key Considerations

Monitoring the CDA Balance:

It’s essential to monitor the CDA balance carefully, as paying out more than the available balance can lead to penalties from the CRA. A 75% penalty tax is imposed under Income Tax Act, section 184(2), if a capital dividend is paid that exceeds the CDA. However, if an excessive election has been made, in certain cases, Income Tax Act, section 184(3) and (4), allows the shareholders to avoid the penalty tax by filing an election to treat the excessive distribution as a taxable dividend.

Strategic Tax Planning:

Using the CDA effectively can be a powerful tool in corporate tax planning, especially for shareholders looking to maximize tax-efficient withdrawals from their corporation.

For additional information, visit the Canada Revenue Agency: Canada Revenue Agency