Site logo

Tax Savings Using Capital Dividends

September 19, 2017

Tax Question:

How do I save taxes using capital dividends?

Facts:

The Canadian tax system allows a corporation to take out tax-free dividends using a Capital Dividend Account (CDA). The CDA includes the following:

  1. The non-taxable portion of the company’s capital gains net of capital losses
  2. The non-taxable portion of gains on the sale of eligible capital property (phased out in 2016)
  3. Proceeds of life insurance policies on death (not discussed below)

Discussion:

When an asset is sold for a profit, 50% of the profit is not taxable. If the asset is owned personally, the owner has direct access to the tax-free profit. If the asset is owned by the corporation, the tax-free profit is trapped inside the company.

The Canadian tax system is based on the concept of integration. It should not matter whether you earn the income inside or outside a corporation, the tax treatment should be equal. Therefore, shareholders are permitted to withdraw the tax-free profit by way of a Capital Dividend and this avoids double taxation. This dividend is not reported on the shareholder’s tax return as no tax is owed on the amount.

In order to designate a capital dividend, you must file an election with Canada Revenue Agency and special paperwork and procedures are required prior to and through the issuance. You should consider the following strategy when deciding to pay out a capital dividend. Pay out the CDA as the balance accumulates before it is eroded by capital losses. For example, you may trigger a large capital gain on a transaction but the CDA balance will be reduced by any future capital losses. Therefore, prior to realizing any capital losses, you should designate a capital dividend to withdraw the tax-free profit.

If you would like more information on this topic, please contact a member of the Empire CPA team by filling out the contact form below.

Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.

Share this post

Related posts