Tax reduction strategies and the use of the capital dividend account (CDA)
A capital dividend (CDA) is a notional account that tracks certain types of income earned by a private corporation resident in Canada, which may be distributed by the corporation as a tax-free dividend to its Canadian resident shareholders.*
When a private corporation is named as the beneficiary of a life insurance policy, a credit to its CDA for the amount of the death benefit proceeds received less the adjusted cost basis of the insurance policy is recorded.
Pyament of tax-free capital dividend may be limited to the amount of retained earnings available to make a payment. For this reason, it’s good that a corporation has flexibility regarding when they declare a dividend.
For purposes of fair market value of corporate shares deemed to be disposed of on death of an insured, fair market value of a life insurance policy is the cash surrended value immediately before death.
*Tax withholding is required if dividend is paid to non-resident shareholder
Capital dividend account benefits
Corporations buy life insurance to arrange funds that they will need for various purposes upon death of the insured, wihtout borrowing or withdrawing money from the business operations. Funds may be required for reasons such as:
- Buy-sell agreement funding.
- Debt coverage for a business line of credit or loan.
- Replacement and training cost.
Benefits of a CDA should be considered when a private corporation is the owner and beneficiary of a life insurance policy. If a life insurance policy is used to secure the indebtedness of a private corporation resident in Canada, and as a consequence of an insured’s death the death benefit is paid directly to the creditor, the CDA credit of the corporation may still included the entire death benefit less any adjusted cost basis of the policy to the corporation. Recent Court rulings have confirmed the corporation only needs to have ‘constructively received’ the death benefit proceeds and the discharching of the corporate debt qualifies as receiving the death benefit for purposes of the credit to the corporation’s CDA.
Capital dividends and the CDA – an integral part of a tax reduction strategy
- CDA is only available to private corporations resident in Canada.
- Corporations don’t have to elect to pay a capital dividend immediately after a corporation receives death benefit proceeds.
- The CDA balance resulting from receipt of death benefit proceeds from a life insurance death benefit will remain until such time as capital dividends are elected. This allows corporations the ability to elect to pay a capital dividend when it’s most advantageous for shareholders.
- Since payment of a capital dividend is elective, detailed knowledge of tax legislation is required. It is recommended your accountant be involved in the election process.
For more information on capital dividends and the CDA, refer to the Income Tax Act, subsections 83(2)and 89(1).
The information provided is based on current tax legislation and interpretations for Canadian residents and is accurate to the best of our knowledge. Future changes to tax legislation and interpretations may affect this information. This information is general in nature, and is not intended to be legal or tax advice.