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.