The capital dividend account (CDA) is used to track the amounts that can be paid out to shareholders, tax free.
How is the capital dividend account balance calculated?
- Capital gains and losses – The balance increases by 50% of any capital gains your company incurs, and decreases by 50% of any capital losses your company incurs.
- Capital dividend payments received – The capital dividend account balance will also increase by any capital dividends paid to your corporation, from another corporation
- Life insurance proceeds – If your corporation receives proceeds from a life insurance policy, and the proceeds are greater than the cost base of the life insurance, then that difference will be added to the capital dividend account balance
- Gains on eligible capital property – 50% of any gains on eligible capital property will be added to the capital dividend account balance.
- Gifting certain publicly traded securities to a qualified charity. The non-taxable portion of the capital gain will also be added to the capital dividend account balance
Year Capital gain / (loss) Non-taxable portion (50%) CDA Balance
1 20,000 10,000 10,000
2 18,000 9,000 19,000
3 (7,000) (3,500) 15,500
4 14,000 7,000 22,500
In this example, the corporation had capital gains in years 1, 2 and 4 which increased the capital dividend account balance by the non-taxable portion of the capital gain. The capital loss in year 3 reduced the capital dividend account balance, by the non-taxable portion of the capital loss. At the end of year 4, the corporation would be eligible to pay out $22,500 in tax free capital dividends to its shareholders.
How is the capital dividend balance paid to shareholders?
In order to receive a capital dividend, you need to have been a shareholder/unit holder when the capital dividend was declared. For example, a capital dividend is declared on November 30, you sell your shares in the company on December 1, but the capital dividend is not paid until December 15. In this instance, you would be entitled to your portion of the capital dividend payment because you were still a shareholder when the amount was originally declared on November 30.
Corporations declaring the capital dividend would have to file a signed form T2054, Election for a Capital Dividend as well as a certified copy of the directors’ resolution declaring a capital dividend. A CDA schedule, showing how the balance is calculated is the last piece that must be submitted.
Note that the T2054 election form is due on or before the earlier of the day that the dividend is paid or becomes payable. The T2054 may be filed late, but CRA charges a non-deductible penalty for each month that the election is late. The penalty is calculated as A x B, where:
A is the lesser of:
- $ 41.67
- 1/12 of 1% of the amount of the dividend
B is the number of months and part-months between the filing due date and the actual date the election is filed
If you are an individual receiving the capital dividend payment you would not receive a T5, as you do with both eligible and ineligible dividend payments. You are not required to report receipt of the capital dividend anywhere on your personal tax return. Corporations and partnerships can also receive capital dividends, but would need to report these amounts on their T2 Corporate Tax Return or T5013 Partnership Return.
What if I declare a capital dividend that is more than the balance in my capital dividend account?
Watch out! The penalty on paying excessive CDA dividends (also known as Part III tax) is equal to 60% of the excess dividend. For example, if your CDA balance was $100,000 and you declared a CDA dividend of $120,000 the penalty would be $12,000! ($20,000 excess x 60%).
You cannot change the amount of a capital dividend once the election has been filed. If you find that an excessive amount has been paid, it is possible to file another election to treat the excess portion as a taxable dividend, rather than a capital dividend. The new dividend would be treated as if it was received at the same time the original dividend became payable. This election (under subsection 184(3)) must be filed within 90 days after the date on the Notice of Assessment on excess dividends is issued. However CRA will not allow the 90 day time limit if there is any misrepresentation or fraud committed when filing the return.
Canada Revenue Agency has recently allowed situations where if you have been assessed part III tax, you can file an objection and still file the subsection 184(3) election noted above. The CRA will hold the election in abeyance until the objection is resolved. Essentially, you would be electing in advance. This way if your objection is not successful, you can still treat the excess portion of the dividend as taxable rather than having the pay the full penalty.
What happens to my capital dividend account balance if I close my corporation?
CDA balances should be paid prior to dissolving or closing your corporation.
If you wind-up a corporation, the existing CDA balances will be transferred to the parent company.
In other cases, you may be distributing all of the corporation’s property prior to winding up the company. If this is the case, all property is deemed to be distributed at market value and is paid as a dividend. This can be costly. For example, property could include securities held and the value of stocks will vary greatly from one day to the next. The corporation can file an election to deem a portion of the dividend to be ‘capital’, as long as it does not exceed its CDA balance. The same T2054 election form should be used.
There may be issues with timing as it will be difficult to determine the market value of property until after the wind-up has occurred. However, CRA has indicated that in these instances, they will adjust a capital dividend to reflect the correct capital dividend account balance as required.
What can I do now?
As you can see, filing a correct CDA election is not easy and paying excessive capital dividends can be costly. It is critical to make sure that the CDA balance is correct, prior to declaring the capital dividend. A request can be submitted to CRA to verify the CDA balance. The request to CRA can only be made once every three years, so careful tracking of the CDA balance is recommended.
For more information on capital dividends from the CRA website, click here.
If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.
Thanks to Stephanie Kwan of KWB Chartered Professional Accountants for providing this content.