Understanding Capital Dividend in Canada: A Comprehensive Guide

The concept of capital dividend plays a significant role in tax planning for individuals and corporations, in Canada. Capital dividends allow for the tax-free distribution of surplus funds generated through capital gains. This article aims to provide a comprehensive understanding of capital dividends, their purpose, eligibility criteria, and the benefits they offer.

What is a Capital Dividend?

In Canada, when an individual earns capital gain from the sale of an asset, only 50% of that gain is taxable. Capital dividends provide the same benefit to private corporations. When a corporation makes a capital gain, 50% of that amount is taxed, and the remaining 50% is tax-free.

The corporation can distribute the tax-free portion, as a capital dividend, to its shareholders through a special account called the capital dividend account (CDA). This capital dividend is not taxed in the hands of shareholders, unlike a regular dividend, which is taxable to shareholders. 

The capital dividend is exclusive to Canada’s private companies. Accordingly, a company that is not privately incorporated in Canada, can not avail the CDA benefit. Also, for capital dividends to non-resident shareholders, a 25% withholding tax applies unless the other country has a special tax treaty with Canada (like the United States).

Eligibility Criteria:

To qualify for a capital dividend, the corporation must have a positive balance in its CDA. The incomes that increase the CDA balance include:

1. The non-taxable portion of capital gains realized on the sale of assets and investments (the most common source)
2. The proceeds of a life insurance policy paid out on death to your corporation as a beneficiary.
3. Capital dividends received from other private corporations.

The balance in the CDA is reduced when one of the following happens:

1. A corporation pays a capital dividend from the CDA account.
2. A corporation realizes a capital loss.

Procedural Requirements for Capital Dividend Payment

1. Capital Dividend Account (CDA) Tracking: Corporations must maintain accurate records of their CDA to ensure compliance with the tax regulations. Any improper distribution from the CDA may result in severe penalties from CRA for both the corporation and its shareholders. The CRA tracks the CDA balance on Schedule 89.

• Approval by the Board of Directors: Before a capital dividend can be declared and distributed, it must be approved by the corporation’s Board of Directors. The board should review the financial statements, assess the availability of funds, and ensure compliance with applicable laws and regulations. The board must pass a special resolution.
• Notification to Shareholders: Once the capital dividend is approved, the corporation must notify its shareholders of the upcoming distribution. The notice should include the amount of the capital dividend, the record date (the date on which shareholders must be on the corporation’s books to be eligible for the dividend), and the payment date.

• Filing of Special Elections with CRA: a corporation that wishes to pay a capital dividend to its shareholders must file a special election with the CRA (Form T2054, Election for a Capital Dividend Under Subsection 83(2) on or before the capital dividend is payable or is paid, whichever is early.

Planning And Timing of Events

In addition to the procedural steps involved in capital dividends, timing the distribution of capital dividends is a very important consideration since some even can impact CDA balance or even its availability. Here are some examples:-

1. Upcoming Capital Loss: if a property is going to be sold at a loss that would result in a reduction of the CDA balance, shareholders may consider distributing capital dividends prior to the sale to take advantage of the available funds.
2. Planning To Go Public: A public corporation is not able to pay a capital dividend. Accordingly, it is prudent planning to ensure that any balance in the capital dividend account is distributed prior to becoming a public corporation.

The above type of events do not happen suddenly, therefore prudent and timely planning can result in a lot of tax savings. If an event could negatively impact CDA, a corporation should consider distributing capital dividends prior to that event. 

Consultation with Tax Professionals: Capital dividends involve complex tax considerations. It is advisable to consult with tax professionals, such as a Chartered Professional Accountant (CPA) or a tax lawyer, who can provide guidance specific to your situation and ensure compliance with the relevant tax laws.

In conclusion, capital dividends provide a tax-efficient way for Canadian corporations to distribute surplus funds from capital gains to shareholders, offering significant tax savings. Careful navigation of the Capital Dividend Account (CDA) and adherence to eligibility criteria, with the guidance of professionals, are essential for compliance with tax regulations. A thorough understanding of capital dividends and their benefits is crucial for optimizing tax planning and wealth management strategies in Canada.

Contact Source Accounting Professional Corporation to discuss how to make the most of the capital dividend account for your corporation.

Seek assistance from tax experts who can help you make the most of the Capital Dividend Account (CDA), corporate tax planning, and other estate planning tools, ensuring that you don’t end up paying a significant portion of your income in taxes. Source Accounting Professional Corporation (CPA) is a full-service accounting firm in Mississauga. We specialize in assisting business and corporation owners with their business plans and tax-saving strategies. Call us at 647-930-8130.

Disclaimer: The above contents are provided for general guidance only, based on information believed to be accurate and complete, but we cannot guarantee its accuracy or completeness. It does not provide legal advice, nor can it or should it be relied upon. Please contact/consult a qualified tax professional specific to your case.