The Basics of Capital Dividends for Private Canadian Corporations
We’ve had several clients come on board who have had no idea that their company had a balance in its Capital Dividend Account - meaning they could pay themselves a tax-free dividend and save thousands of dollars in personal tax. This shouldn’t be a surprise to any business owner, so we thought we’d put together a straightforward guide to help you understand what this account is, how it can save you a lot of money, and the steps to use it effectively.
What is a Capital Dividend Account (“CDA”)?
The Capital Dividend Account is a special account that allows Canadian-controlled private corporations (CCPCs) to distribute tax-free dividends to shareholders. This account includes the non-taxable portion of capital gains and certain other tax-free amounts like life insurance proceeds.
An Example of the Tax Savings
Let's say your corporation realizes a capital gain of $200,000. Under the new rules effective June 25, 2024, 66.67% of this gain will be taxable. In other words, this means $133,340 is taxable, and $66,660 will be added to the company’s CDA. When you pay out this $66,660 as a capital dividend, the company’s shareholders receive it tax-free, which could save them tens of thousands in personal tax versus a regular dividend being paid from the company.
Calculating the CDA Balance
Like many areas of corporate tax, there is fine print and potential complexity, but in simple terms the CDA balance includes:
The non-taxable portion of capital gains;
Non-taxable life insurance proceeds; and,
Capital dividends received from other corporations.
You then need to subtract any capital losses and previously paid taxable capital dividends to arrive at the current available balance in the account.
An Election is Required
To pay a capital dividend, a special election has to be filed with the Canada Revenue Agency (CRA) using Form T2054, along with some director’s resolutions. This form must be submitted before the capital dividend is paid, or late filing penalties can be assessed. This election allows you to designate the dividend that will be paid as capital, and confers the tax-free status on the distribution from the company.
Timing is Key
Timing is everything with the CDA! As mentioned above, capital dividends can't be paid until after a special election is filed. Also, selling investments at a loss before making a capital dividend election will reduce your CDA balance and the amount you can distribute from the company tax-free. Careful planning and regular touchpoints with your accountant will help you plan and optimize the use of your CDA to ensure you don’t run into problems.
Verifying Your CDA Balance
We almost always perform a CDA balance verification when assisting a client through this process, before filing the election. It’s critical to have the numbers right, because incorrect capital dividend elections result in a hefty 60% tax on any excess dividends paid out. You can request a balance verification by submitting a specific form (Schedule 89) to the CRA. Although it slows down the process, this step is well worth it as it ensures that your calculations are accurate, and that the payout will in fact be tax free.
Final Thoughts
Properly managing your Capital Dividend Account can lead to thousands of dollars in tax savings, so it’s an important concept for any Canadian business owner to be aware of - particularly if your corporation holds investments.
We would be thrilled to help you navigate the complexities of tax planning and making the most of your CDA. Please feel free to reach out for a discovery meeting anytime if you have any questions.
Clearpath Accounting provides resources such as this for general information purposes. The topics are dynamic, time-sensitive, and complex, and may not apply to your particular facts and circumstances. The information provided should not be relied upon as a substitute for specialized professional advice in connection with any particular matter.