Unlock the Power of Your Corporate Assets Using the Capital Dividend Account (CDA)

Taxation for corporations operates differently than for individuals. Incorporated business owners can leverage several advantages, including tax deferral, income splitting, and tax-efficient dividend strategies. However, one of the most powerful yet under-utilized benefits is the Capital Dividend Account (CDA) – allowing corporations to distribute tax-free dividends to their shareholders.

With marginal tax rates in Canada exceeding 50% in some provinces, Canadian-Controlled Private Corporations (CCPCs) can use their CDA to optimize tax planning and reduce unnecessary tax burdens on shareholders.

What Is the Capital Dividend Account (CDA)?

The Capital Dividend Account is a notional tax account, meaning it doesn’t hold cash or appear on financial statements. Instead, it tracks tax-free surpluses that corporations can distribute to Canadian shareholders in the form of tax-free dividends.

What Can Be Added to a CDA?

Several tax-free amounts contribute to a corporation’s CDA balance, including:

1. The Non-Taxable Portion of Capital Gains

• • In Canada, capital gains are currently subject to a 50% inclusion rate, meaning only half of a realized capital gain is taxable, while the other half remains tax-free. The tax-free portion is added to the CDA and can be distributed to shareholders a tax-free capital dividend.
  • Example: Suppose Consolidated Moose Pasture Holdings Inc. realizes $200,000 in capital gains: $100,000 is taxable, and the remaining $100,000 increases the corporation’s CDA balance.

2. Tax-Free Dividends from Other Corporations

1. • If a corporation receives capital dividends from another entity, the full amount is credited to the receiving company’s CDA, allowing it to be redistributed tax-free.

3. Life Insurance Death Benefits

   • If the corporation is named as the beneficiary of a life insurance policy, the payout (minus the adjusted cost base of the policy) can be added to the CDA for tax-free distribution.

At Lighthouse Wealth Management, we primarily work with our corporate clients on the 1^st option (the non-taxable portion of capital gains). Below is a flowchart illustrating the process of claiming a capital dividend.

Step-by-Step Breakdown

Why Does the CDA Exist in Canada’s Tax System?

The Capital Dividend Account was created to ensure fair tax treatment through a principle called tax integration. The goal is to prevent double taxation, ensuring that income earned within a corporation and distributed to shareholders is taxed equally to income earned directly by an individual.

Without CDA provisions, dividends paid by a corporation would be double-taxed – first at the corporate level and again in the hands of the shareholder.  CDA rules ensure that tax-free portions of capital gains and certain life insurance payouts remain untaxed, just as they would if the shareholder held the assets personally.

How Can Business Owners Declare Tax-Free Dividends?

Business owners must take the following steps to distribute capital dividends tax-free:

• Request a CDA Balance
• • Corporations can verify their CDA balance through the Canada Revenue Agency (CRA).
• File a Capital Dividend Election
• • A corporation must file a capital dividend election with the CRA before or on the date the dividend is paid. The filing should include:
    • A certified director’s resolution authorizing the capital dividend.
    • A detailed schedule showing the corporation’s CDA balance calculation before the election.

Strategic Planning for Capital Dividends

We consult with our corporate client’s CPAs to conduct year-end tax planning to optimize their CDA usage and determine if any corporate tax paid can be recovered. We do this by:

• Reviewing realized capital gains and losses throughout the fiscal year to help identify whether capital dividends should be declared.
• Recommend capital dividends if the company has significant unrealized gains that may face a higher inclusion rate in the future.
• Review balances of refundable dividend tax on hand to assess available corporate tax recovery options and optimal corporate distributions.

Potential Future Tax Changes

The current inclusion rate for capital gains is 50%, but in the 2024 budget, there was a proposed increase to 66.67% for corporations and trusts, and for individuals exceeding $250,000 in annual capital gains. If this change is implemented, it could impact CDA balances. Corporations holding investments with large unrealized gains may see higher tax liabilities when realizing profits.

For example:

• If a corporation has investments with a book value of $600,000 and a market value of $1,000,000, the unrealized gain is $400,000.
• At the current 50% inclusion rate, only $200,000 is taxable.
• If the inclusion rate increases to 66.67%, then $266,680 becomes taxable – significantly raising the corporate tax burden.

By strategically realizing gains while the inclusion rate remains at 50%, corporations can maximize their CDA balances and distribute tax-free dividends before potential adverse tax changes occur.

Final Thoughts: Maximize Your CDA Strategy

The Capital Dividend Account is a powerful tax planning tool that allows incorporated business owners to accumulate more tax-paid personal assets while optimizing their corporate distribution strategy and minimizing personal tax liabilities. Working closely with your accountant and wealth advisor can ensure you get the most personal benefit from the work you put into building your business and that CDA elections are timed strategically and executed correctly for maximum benefit.

For business owners who haven’t yet explored their CDA strategy, now is the time to reach out for a consultation with Lighthouse Wealth Management.

A well-planned approach to managing your corporate assets can lead to significant tax savings, increased financial flexibility, and a better standard of living for you and your loved ones.

Disclaimer

This article is a general discussion of certain issues intended as general information only and should not be relied upon as tax or legal advice. Please obtain independent professional advice, in the context of your particular circumstances.