The capital dividend account, explained

Most money leaving a corporation is taxed twice, in the company and in the shareholder’s hands. The capital dividend is the rare exception: it moves cash to a Canadian-resident shareholder with no personal tax. But it can only come from amounts the corporation genuinely received tax-free, and needs a formal election.

What the CDA is

The capital dividend account is not a bank account and is not on the financial statements. It is a notional running total, defined in subsection 89(1) of the Income Tax Act, of untaxed amounts the corporation received. If it was not tracked since incorporation it must be reconstructed, so 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 realizes 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 authorizing 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 brings a penalty under paragraph 83(3)(b), calculated and paid on filing: the lesser of one per cent of the dividend and $500, each pro-rated by the months or part-months between the due date and filing. Daily compound interest runs on anything unpaid. The deadline for form T2054 runs from the day the dividend becomes payable, not your year-end. See what form T2054 requires and when it is due, or use the T2054 deadline checker.

Electing on more than you have

This is the expensive one. If the elected dividend exceeds the CDA balance, only 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 each recipient shareholder is jointly and severally liable for their share. A subsection 184(3) election can treat the excess as an ordinary taxable dividend, but generally needs agreement from every shareholder entitled to the original dividend.

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. A non-resident faces Part XIII withholding at 25 per cent, subject to treaty reduction, reported on an NR4 slip. If a shareholder has left Canada, deal with it before declaring.

When owners actually use it

The CDA usually surfaces at three moments: after the corporation sells an investment property or portfolio position at a gain; after a life insurance claim; and on a sale or wind-up, alongside the lifetime capital gains exemption and ordinary dividends. Check it before dissolving a corporation, because an unused balance disappears.

If your corporation has ever realized 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.

Whether any of this applies to you turns on your year-end, your structure and what else is in the picture — ask about your own situation and a CPA replies, usually the same business day. Free either way.

Donating appreciated securities through the corporation is one of the cleaner ways to add to this account — see donating personally versus through your corporation.

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.