Are you eligible for a tax-free dividend?
Sunday, December 22nd, 2019
If you are an owner of a private corporation, then certain transactions could provide you with an opportunity to make tax-free withdrawals from your company. These tax-free withdrawals occur in the form of a capital dividend from your Capital Dividend Account.
What is a Capital Dividend Account (CDA)?
The CDA is a notional account that private corporations use to track tax-free surpluses which accumulate over time and can be paid out as tax-free capital dividends to its Canadian resident shareholders.
How is the value of a CDA derived?
The most common tax-free amounts that increase a CDA balance are:
- Non-taxable portions of capital gains
- Capital dividends received from another corporation
- Net proceeds of a life insurance policy
A CDA balance is commonly decreased by:
- Capital dividends paid
- Non-deductible portions of capital losses
Here is a simple example to illustrate how a CDA balance calculation works:
Private corporation, ABC Inc. has an opening CDA balance of nil at January 1, 2019. On April 1, 2019, ABC Inc. sells a capital asset and realizes a capital gain of $300,000. Currently, only 50% of the gain is taxable, and so the CDA balance will increase by the non-taxable amount of $150,000. On October 1, 2019, ABC Inc. sells another capital asset, but this time realizes a capital loss of $100,000. Similar to a capital gain, the loss has a non-deductible component equal to 50% of the capital loss. Consequently, $50,000 —the non-deductible capital loss—will reduce the CDA:
|January 1, 2019||$0|
|April 1, 2019||$150,000|
|October 1, 2019||($50,000)|
Based on the illustration above, ABC Inc. has a CDA balance of $100,000 at October 1, 2019, which could be distributed to its shareholders tax-free as a capital dividend.
Paying Capital Dividends
An election must be filed to pay out a capital dividend. This election should be made by the earlier of: the day on which the dividend becomes payable, or, the first day on which any part of the dividend is paid.
It should be noted that any capital dividends paid to non-resident shareholders are subject to a non-resident withholding tax of 25%. This withholding tax may be reduced if the dividend is paid to a shareholder who is a resident of a country that has a tax treaty with Canada.
Corporations should also be careful not to make an ‘excessive election’—meaning that a corporation elects to distribute an amount greater than its CDA balance. This will result in additional tax (Part III tax) for the corporation equal to 60% of the excess amount plus interest. In order to avoid Part III tax on an excessive election, a corporation could elect to treat the capital dividend as a regular taxable dividend. The shareholder is taxed on this dividend, but their overall tax should be less than the Part III tax.
There are a lot of factors to consider. The tax team at S+C Partners would be happy to answer any questions you have regarding Capital Dividend Accounts.