Capital dividends are a unique form of dividend that Canadian-controlled private corporations (CCPC) can distribute to their shareholders without incurring any taxes. To keep track of these tax-free dividends, the Canada Revenue Agency (CRA) maintains a capital dividend account (CDA). The purpose of capital dividends is to enhance the integration of the Canadian tax system by ensuring that shareholders receive similar benefits from capital gains earned within a corporation as they would if they had earned those gains personally. The tax laws surrounding capital dividends are intricate, and our CPA-CA accounting firm in Edmonton can provide further information or assistance with claiming these dividends. In this blog post, we will discuss the most common transactions that affect the CDA balance, while our next post will cover fewer common transactions and additional CDA considerations.
Selling Capital Property for Tax-Free Capital Dividends
One of the most common ways to increase the CDA balance is by selling capital property (such as stocks, land, or bonds) at a profit. This is known as a capital gain, which occurs when the proceeds from the sale are higher than the cost of the property, factoring in any associated fees. However, only 50% of this gain is added to the CDA balance and considered non-taxable. The other 50% is taxable and included in one’s income for that year. Conversely, losses on capital property sales can decrease the CDA balance. In this case, 50% of the loss is offset against any capital gain additions and can reduce the CDA balance. It’s important to note that losses cannot create a negative CDA balance; instead, any non-deductible portion of losses accrues until there are enough non-taxable portions of capital gains to offset them. See Year 1 and Year 2 in the example below for more information.
Regarding the taxable portion of capital losses, if there is any remaining 50% of the taxable capital loss, it will be applied to the current year’s taxable capital gains. If there are no taxable capital gains to apply it to, the loss can be carried forward for future use or carried back up to 3 years to set against taxable capital gains. When it comes to selling depreciable capital assets, things can get more complicated from a CDA perspective. This is because these assets usually don’t increase in value, resulting in no capital gain or loss. However, in rare cases where they do increase in value, complex rules come into play to ensure that the correct capital gain versus recapture on depreciation is calculated accurately. As these issues are complex, taxpayers should seek advice from a tax accountant with a CPA (Chartered Professional Accountant) or CA (Chartered Accountant) designation. Our CPA-CA accounting firm based in Edmonton has extensive experience in income tax matters and would be happy to assist you with any questions you may have.
Let’s consider our example where a single individual shareholder owns the corporation and there is no other activity in each year.
At the start of Year 1, the CDA balance is zero. In Year 1, a stock was sold for $500,000 with a cost base of $100,000, resulting in a capital gain of $400,000. Half of this gain is included in income for tax purposes while the other half is allocated to the CDA balance. The taxable income for the year is $200,000 and the closing CDA balance is also $200,000. Although the corporation can pay a capital dividend of $200,000 to its shareholder without any personal taxes being paid by them, it chooses not to do so in Year 1.
Moving on to Year 2, land with a cost base of $600,000 was sold for $100,000 resulting in a capital loss of $500,000. Out of this loss amounting to $250,000 that is taxable; $200,000 would be carried back to Year 1 while the remaining $50,000 would be carried forward as taxable capital loss. The other half of this capital loss would be allocated to the CDA balance. As losses on a capital property do not create negative CDA balances; there would be no taxable income in Year 2 and hence the CDA balance would be nil. However, there are losses accrued amounting to $50,000 ($200,000 gain from Year 1 less $250,000 loss in Year 2) that need to be offset so as to bring the CDA balance above nil.
The skilled and knowledgeable team at Filing Taxes is dedicated to guiding you towards the best course of action based on your unique business circumstances.