The Capital Dividend Account (“CDA”) tracks the non-taxable portion of certain corporate income items, in order to ensure that they remain available as non-taxable amounts when they are distributed to shareholders. Generally, the CDA is made up of a number of elements. The first and most common is the non-taxable portion of capital gains, less the non-allowable portion of capital losses.
When a positive balance is available in the CDA account, common wisdom is to pay it out to shareholders as quickly as possible. The main tax reason is to avoid a reduction in the balance in the account due to future capital losses. However, when it comes to the calculation of the CDA at a given point in time, care must be exercised. This is because, there are certain items that do not effect the CDA balance immediately, causing difficult, and sometimes expensive problems for taxpayers.
Members of Partnerships
Where a corporation is a member of a partnership that sells capital property during a taxation year, the allocation of the capital gain to the corporation will not technically take place until the year end of the partnership. Accordingly, the CDA balance of the corporation will not be increased until after the partnership’s year end.
Sale of Goodwill
If a corporation sells its assets, there will be a number of tax consequences, including capital gains, recapture of depreciation, and the sale of goodwill, or cumulative eligible capital (“CEC”). Proceeds from the sale of CEC is treated in a similar manner to a capital gain; however, the income inclusion is technically not considered a capital gain. It arises from a negative balance in the CEC account at the end of the fiscal year. Therefore, the addition to the CDA account on the sale of goodwill or other CEC does not take place at the time of the sale, but rather, at the year end of the corporation, and no CDA election should be undertaken until the first day of the new taxation year.
A capital gain results from the disposition of capital property. However, the courts are regularly hearing tax cases involving the distinction between income and capital gains. When a property is sold and the taxpayer reports it as a capital gain, if there is any question that the gain could be viewed by the CRA as regular income, it may be prudent to delay the CDA election until the issue is settled, or the limitation period for reassessment has expired.
The consequences to any of the above traps is that a CDA election will have been made prematurely, with an insufficient balance in the account. The consequences may be dire. A 75% penalty tax under Part III of the Act is assessed. The only remedy is to request that the excess amount be treated as a taxable dividend. A CDA dividend cannot simply be revoked, because the payment of the dividend is a legal event, and cannot easily be undone or cancelled.
So in making a CDA election, you should hold off long enough to ensure that your CDA balance is not in any doubt.