While traditionally dividends are distributed as non-eligible dividends, entrepreneurs can elect for a tax-free capital divided. This strategy is particularly effective for owners who have realized capital gains and/or hold life insurance policies within the corporation.

Understanding Capital Dividends:  

Capital dividends are specially elected dividends that are tax-free to Canadian resident shareholders and entities. These payments are drawn from an account called the Capital Dividend Account (CDA).

The CDA balance is calculated as:

         The untaxed portion of net realized capital gains

Add:  The full gain received by the corporation as beneficiary of a life insurance policy

Add:  Any capital dividends received from other corporations

Less: Any prior capital dividend payments

Example:

Your company purchases $15,000 worth of shares in Company A. Later, you sell those shares for $30,000, which leads to a capital gain of $15,000. Since only 50% of a capital gain is taxed, the remaining amount ($7,500) represents the untaxed portion and is added to your CDA. This amount can be distributed to you as a tax-free capital dividend when the appropriate election is made.

Requirements To Receive

For a company to declare a capital dividend successfully, the following steps must be taken to avoid penalties:

-         File Form T2054: It must file a T2054 under subsection 83(2) with the Canada Revenue Agency.

-         Timing: The election must be made on or before the date the payment is paid/become due to shareholders.

-         Certified Records: The corporation will need to have/send a copy of the director(s) authorizing the capital dividend.

-         Balance Verification: If the corporation has never filed a T2054 or disagrees with the CRA on the CDA balance, then a            Schedule 89 must be prepared and attached.

Warning: If the capital dividend is paid before the filing of the T2054, the corporate will be subject to penalties and interest which are non-deductible to the corporation for tax purposes.

Avoiding the 60% Penalty

If a corporation declares a capital dividend that exceeds the available balance, it will lead to the excess being taxed at 60%. Therefore, it is essential to make sure your calculation of the CDA matches the records of the CRA before declaration. Also, only make the payment after you have confirmed the balance/payment amount is eligible.

You can strategize how much you pay yourself by declaring a capital dividend when it is at a material amount saving on cost related to electing and paying before realizing any capital losses.

Guidance

Navigating the complexities of capital dividends can be time consuming, but the tax savings can be substantial. At Orion Inc., we ensure your filings are accurate and your financial strategy is optimized to your needs. For more information contact Orion Inc. by e-mail at info@orioninc.ca or call (365) 809-0334.