As I mentioned in a previous blog, the capital dividend account (“CDA”) is often a central feature of tax planning for individuals with private corporations with the opportunity to make tax-free distributions to shareholders on the disposition of certain capital assets. It gains particular focus in estate planning scenarios and eventually in estate and trust administration.
As I also mentioned, the management of the CDA is a tricky proposition with many details to consider, including the dating of resolutions to make distributions from the CDA for instance.
A recent court case highlighted the perils of “misdating”
A company with an October 31 year end sold its business in May realizing a capital gain for the company. A portion of the gain was to be paid out tax-free to the shareholders as a capital dividend provided the appropriate elections were made. The capital dividend was to paid out on November 1. The directors resolution and capital dividend election were dated October 31, 2012. As the corporation had no balance in the CDA on October 31, the result was a punitive tax (up to 60%) on the intended distribution.
In this case, in order for the dividend to a qualify as a tax a tax-free payment out of the CDA, it was necessary for the dividend to be declared and payable after a year end, at which point the gain arising from the sale would be added to the CDA. Although not mentioned in the precis, the sale of business likely triggered the disposition of eligible capital property and thus a year end was needed as described.
Faced with this problem, the corporation and its shareholders went to Court to seek rectification to amend the error in dating of the capital dividend election and directors resolution. Notably, the Canada Revenue Agency did not oppose the requested rectification.
The corporation and its shareholders got the rectification order it sought. The court noted there was a specific intention to allocate proceeds of a transaction to a specific tax account (notably the CDA) to achieve the specified goal of being a tax free distribution. However, the court determined there was a simple mistake (incorrect dating of the key documents) in the implementation of that intent. The court also noted that the error(s) arose from carelessness and miscommunication.
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