Subject to the relevant sections of the Income Tax Act, a Canadian private corporation has a special corporate tax account known as a capital dividend account (“CDA”) which gives shareholders designated capital dividends, tax free.
The CDA of a corporation may include the non-taxable portion of the company’s capital gains, proceeds of life insurance policies on death and capital dividends received from other companies.
While a capital dividend is normally tax free to a Canadian resident, it is usually subject to withholding tax when paid to a non-resident.
Let’s say a Canadian resident trust or estate owns shares of a Canadian private corporation, receives a capital dividend, and then distributes it to a non-resident beneficiary? Is it subject to tax?
According to a recent blog by Michael Atlas, it more likely than not that it is taxable.
At first glance, a trust income distribution to a non-resident may not subject to tax under the Income Tax Act if the distribution is not derived from taxable income of the trust e.g. a capital dividend.
However, if you dig deeper as Mr. Atlas has, there are a couple of provisions in the Income Tax Act which characterize certain distributions to or from the trust to the beneficiary as income such that a capital dividend, being essentially a distribution of capital, is defined as income from a trust or estate even if the capital dividend is added to the trust’s capital and distributed at a later date.
In addition, Mr. Atlas does not believe American residents can access a treaty exemption in this regard.
Life for a trustee or an executor of trust or an estate with non-resident beneficiaries has its own complexities. Here is another one to add to the pile.