The capital dividend account, explained

Most money that comes out of a corporation is taxed twice — once inside the company and again in the shareholder’s hands. The capital dividend is the rare exception. It moves cash from the corporation to a Canadian-resident shareholder with no personal tax at all. The catch is that you can only pay it out of amounts the corporation genuinely received tax-free, and you have to make a formal election to do it.

What the CDA is

The capital dividend account is not a bank account and it is not on the financial statements. It is a notional running total, maintained under the definition in subsection 89(1) of the Income Tax Act, of amounts the corporation has received that were never taxed. Because it is notional, nobody keeps it for you. If it has not been tracked since incorporation, it has to be reconstructed — which is why the CRA asks for a computation schedule with the election.

What feeds the account

The CRA’s folio on capital dividends lists the components. In an owner-managed company, three of them do almost all the work:

• The tax-free portion of capital gains. When the corporation realises a capital gain, only part of it is taxable. The non-taxable part is added to the CDA — but only to the extent capital gains exceed the non-deductible portion of the corporation’s capital losses. Losses reduce the account.
• Life insurance proceeds. Proceeds the corporation receives on the death of a life insured under a policy it owns are added, net of the adjusted cost basis of the policy. This is why corporate-owned insurance is so often paired with a buy-sell agreement.
• Capital dividends received from another corporation. If your holdco receives a capital dividend from your opco, the amount lands in the holdco’s CDA and can be pushed out again. That is one of the practical arguments for a holding company structure.

Certain distributions from trusts can also add to the balance. Capital dividends the corporation pays out reduce it, dollar for dollar.

How the election works

Paying a capital dividend is a two-step act. First the directors declare a dividend and stipulate the day it becomes payable. Then the corporation elects, under subsection 83(2), to have that dividend treated as a capital dividend.

The election is made on Form T2054. Three points matter:

1. Timing. The election is due on or before the earlier of the day the dividend becomes payable and the first day any part of it is paid. That is often long before the corporate return — do not wait for the T2 filing deadline.
2. All or nothing. The election must be made on the full amount of the dividend. A dividend cannot be split into a capital part and a taxable part; if you want both, declare two dividends.
3. Attachments. A certified copy of the directors’ resolution authorising the election, and a schedule computing the CDA balance immediately before the election, have to go with the form. Schedule 89, Request for Capital Dividend Account Balance Verification, can be used for the computation, and the CRA asks for it when a corporation has never filed a T2054 or Schedule 89 before.

The two ways this goes wrong

Filing late

A late T2054 is still accepted, but paragraph 83(3)(b) imposes a penalty and the corporation has to calculate and pay it when it files. The form works it out as the lesser of one per cent of the dividend and $500, each pro-rated by the number of months or part-months between the due date and the filing date. Daily compound interest runs on anything unpaid.

Electing on more than you have

This is the expensive one. If the elected dividend exceeds the CDA balance, only the amount equal to the balance is a capital dividend. Under subsection 184(2), the corporation pays Part III tax of 60 per cent on the excess, plus interest, and every shareholder who received part of the dividend is jointly and severally liable for their proportionate share. There is a relieving election under subsection 184(3) that recharacterises the excess as an ordinary taxable dividend, but it generally requires agreement from all shareholders who were entitled to any part of the original dividend — which is not always easy to get.

The defensive move is simple: verify the balance before you declare. The CRA shows a CDA balance in My Business Account, and Schedule 89 exists precisely so a corporation can ask for it to be verified.

Non-resident shareholders

A capital dividend is tax-free to a Canadian-resident shareholder. Paid to a non-resident, it is subject to Part XIII withholding tax at 25 per cent, subject to reduction under a tax treaty, and it must be reported on an NR4 slip. If any shareholder has left Canada, deal with that before declaring.

When owners actually use it

The CDA tends to surface at three moments: after the corporation sells an investment property or a portfolio position at a gain; after a life insurance claim; and on a sale or wind-up, where a capital dividend can be paid alongside the lifetime capital gains exemption and ordinary dividends to clear out the company. It is also worth checking before dissolving a corporation, because an unused balance simply disappears.

If your corporation has ever realised a capital gain or owned a life insurance policy, it is worth finding out what the balance is. Compared with paying the same cash as an ordinary taxable dividend, the difference is the entire personal tax bill.

This article is general information, not tax advice for your specific situation. Tax rules and CRA administrative positions change — confirm anything that affects a decision with the CRA or with us first.