The capital dividend account (“CDA”) is a tax free surplus account within a private corporation which gives shareholders designated capital dividends, tax-free. The CDA typically contains the non-taxable portion of the company’s capital gains net of capital losses, capital gains received by other companies, proceeds of life insurance on death and other capital like distributions.
The CDA account is often a central feature of tax planning for individuals with private corporations. It gains particular focus in estate planning scenarios and eventually in estate and trust administration.
What has dogged taxpayers and tax practitioners alike over the years, is the difficulty of keeping track of the CDA. CDA account calculations are cumulative and can cover many years. Sometimes, it can be difficult for a taxpayer and the advisor to be certain that the calculation of the CDA is accurate, for example, due to lost data or a change of advisers. In other circumstances, the company may have amalgamated or merged with other private companies with significant (and sometimes undocumented) impact of the CDA balances.
Computing the CDA is the taxpayer’s responsibility and until recently, the Canada Revenue Agency (“CRA”) would not confirm the balance from its records until a formal election for a capital dividend was filed with the CRA. If the CDA is improperly calculated, the taxpayer could have to pay a penalty or make an election to treat an excess amount as a taxable dividend. In either case an unexpected, and unwanted, additional cost usually arises, leading to higher administrative costs and, in extreme cases, litigation between taxpayers and their advisers.
Recently, the CRA introduced measures to give taxpayers access to the CRA’s calculations prior to filing an election to issue a capital dividend. With the introduction of Schedule 89, the components making up the CDA balance will be summarized as at a date specified. This schedule can be used to request a CDA balance verification, or be attached to form T2054, election for a capital dividend under Subsection 83(2) of the Income Tax Act, if you are paying out a capital dividend from the CDA. The CRA notes that it verifies the CDA Balance is a matter of courtesy.