A capital dividend can be classified as what is paid out, tax-free, to Canadian shareholders. These payouts are distributed from the capital dividend account (CDA), which is a cumulative, pooled balance that accumulates based on components covered below.
A capital gain occurs when an investment or real property is sold for greater than the adjusted cost base. The adjusted cost base is the original cost of the investment plus any expenses incurred to make the purchase.
The capital dividend account can accumulate based on various components. These components are treated separately; thus, if you have a negative balance in any of these components, they will not offset the balance in another component. Let’s clarify a little more: the below three components should be treated as separate pools/funds.
The 3 Primary Components
- The non-taxable portion of capital gains:
- This component is in excess of the non-deductible portion of capital losses.
- The non-taxable portion of the capital gain from October 2000 to the present date is 50% of the capital gain. Prior to that, the non-taxable portion is a reduced percentage, depending on the year.
- A capital gain resulting from taking a dividend in excess of safe income is not considered an addition to the CDA balance.
- Capital dividends received by the corporation:
- The full amount of the capital dividend received would be added to the capital dividend account.
- Life insurance policy proceeds:
- The net proceeds are added to the CDA. The net proceeds are the proceeds received less the adjusted cost base of the policy.
- To determine the ACB, take the sum of all premiums less the cost of pure insurance.
How to Make an Election to Receive a Capital Dividend
- File a signed Form T2054: Election for a Capital Dividend Under Subsection 83(2).
- The form must be filed with a schedule showing the calculation of the CDA balance immediately before the election.
- The form cannot be backdated without.
- If the form is late-filed, a penalty must be paid along with the election. The late filing penalty is the lesser of $41.67 or 1/12 of 1% of the amount of the dividend per month late.
Be careful that you are accurately tracking your CDA balance because the capital dividend cannot exceed the CDA balance. Any amounts in excess of the CDA balance will be taxed (called Part III tax) at 60% of the excess amount plus interest. However, an election can be made to avoid the Part III tax, whereby, the excess capital dividend will be treated as an ordinary dividend to the recipients. To avoid paying excess capital dividends, corporations can confirm their CDA balance with the CRA. This service is only available once every three years.
Non-residents can receive a capital dividend; however, it will be subject to a non-resident withholding tax of 25%. This tax rate could be reduced if there is a treaty with Canada.
There are some additional complexities associated with capital dividends, so please consult your accountant when considering issuing a capital dividend.
- The capital dividend account (CDA) is a special corporate tax account that gives shareholders designated capital dividends, tax-free.
- When a company generates a capital gain from the sale or disposal of an asset, 50% of the gain is subject to a capital gains tax. The non-taxable portion of the total gain realized by the company is then added to the capital dividend account (CDA), which is then distributed to shareholders.
- The balance in the CDA increases by 50% of any capital gains a company makes and decreases by 50% of any capital losses incurred by the company.
- Only Canadian residents can take advantage of the tax-free benefits of receiving a capital dividend.