Capital Dividend Account Basics

Improving financial literacy is a giant leap toward growth and stability in these turbulent times. The importance of having adequate savings, investments, and insurance funds become more evident. The increased capital inflows are manifestations as the financial market expands further. At some point, the uncertainties benefited both the investors and businesses. 

So, when running a business today, watching and growing all aspects can be relatively easy. But of course, taxation becomes more complex, especially to larger businesses and those open to public scrutiny. One of the most confusing concepts is the Capital Dividend Account (CDA). Hence, we will take a closer look at the basics of the CDA in Canada. 

What Is a Capital Dividend Account?

The Capital Dividend Account (CDA) is a tax account commonly used in Canada. It is a special corporate tax account that distributes tax-free dividends to the shareholders. The CDA is not a taxable entry in the financial statements because of its nature. But it may still be reported in the notes to financial statements.

Capital dividends are the payments given to the shareholders. The payment is pulled out from the amount raised from stock issuances or paid-in capital. One must not confuse it with regular or ordinary dividends from retained earnings. 

They are not subject to taxes in contrast to ordinary dividends. These should be treated as capital returns to the investors, not a part of company earnings. This is because capital dividends are associated with capital gains, not the profit before tax. But investors must still be careful since these may indicate the company’s struggle to pay ordinary dividends. The lack of liquidity or spare cash must be included as well. 

Capital gains are derived from the sale or disposal of assets. The first 50 percent of the proceeds or capital gains are taxable. The other half is distributed to CDAs. So the CDA balance increases by 50 percent when there are capital gains and vice versa. It increases when the company invests in other corporations that distribute capital dividends. The proceeds from life insurance and trust may also be added to the CDA balance. 

How Does a Capital Dividend Account Work?

The common classification is eligible or ineligible dividends when receiving and distributing dividends. These are ordinary dividends taken out of the company’s retained earnings. They can be in the form of cash dividends or stock dividends. So taxation applies to the sale of shares or withdrawal of dividends. Capital dividends differ from them. 

The Capital Dividend Account or CDA is typical in Canada. It is part of its Income Tax Act system of integration. Tax integration ensures that the CDA allows a corporation to distribute tax-free amounts to the shareholders. It also shows that company earnings are still subject to taxation, whether generated by the company or an individual. 

Both parties must determine when to effect the capital dividend payment. But these can only be declared if the balance is positive. So, businesses and investors must talk with tax experts to avoid declaring multiple dividends, subject to 60 percent tax of the excess dividends. 

Meanwhile, a non-Canadian shareholder must pay a 25 percent withholding tax on capital dividends. But the withholding tax rate may be lowered if the shareholder is a resident in a country with a tax treaty in Canada like the US. For example, an American investor with capital dividends will be subject to a lower tax rate. From 25 percent, the treaty will decrease it by 20 percent, so the final tax rate is 5 percent. 

But whether a Canadian or not, timing is integral to avoid the pitfalls of the CDA. The capital loss realization and capital dividend payment timing is important. With the help of tax experts, careful tax planning/consulting for individuals and businesses is attainable. 

How Is the Dividend Declared in Ontario? 

The corporate directors are responsible for declaring dividend payables. But they can only be declared when the CDA has a positive balance. The parties will also elect using Form T2054 or “Election for a Capital Dividend Under Subsection 83(2).” It indicates the dividend paid amount, the payment date, and any late-filing penalties. 

They must be careful with the estimation so the declared dividend will not exceed the CDA balance, avoiding taxes and penalties. The CDA balance and its components can be estimated in Schedule 89 of the form. It is better to talk with experts for voluntary disclosures and audit assistance. 

Consult with Our Toronto Tax Lawyers Who Have More Than 25 Years of Experience

The Capital Dividend Account (CDA) nature may be simple at first glance. Capital dividends are tax-free and comprehensible for Canadian residents. But the estimation and declaration require careful tax planning. Hence, you may talk with the experts from Taxpage.com to help you with your investment and taxes. 

Did you find this article informative? If you have any questions or concerns about capital dividends, please call our Toronto tax lawyers. Taxpage.com provides expert advice and tax solutions on problems in various fields. For additional information, check out more blogs on our page. 

FAQs on Capital Dividend Account Basics

1. How do you pay out a capital dividend account? 

The payment for the capital dividend account (CDA) is through capital dividends taken out from paid-in capital. 

2. How do I check my capital dividend account balance? 

Taxpayers or tax representatives can request information from the Canada Revenue Agency (CRA). 

3. Does a capital dividend have to be paid in cash? 

The capital dividend can be paid in cash or stock dividends.