GET TAX FREE PAY FROM CAPITAL DIVIDEND ACCOUNT
Originally published on July 26, 2012
The capital dividend account is a notional account used solely for tax purposes.
It does not appear on your company’s balance sheet but will be reported on your corporate tax return, either on your corporate tax summary or capital dividend continuity. Non-taxable capital dividends may be paid from this account.
Your farming company’s CDA is determined on a cumulative basis beginning at the start of your corporation’s first taxation year (after 1971) to the time of computation. It comprises the following amounts:
• the non-taxable portions of capital gains less the non-deductible portion of the capital losses realized during the defined period. These net amounts can be retrieved from Schedule 6 on your previously filed corporate tax returns
• capital dividends received by other companies or trusts
• the non-taxable portion of appreciation in the value of eligible capital property realized on its disposition. For farmers, the disposition of its dairy or broiler quota would fall into this category
• the proceeds from the company’s life insurance policy on a key employee in excess of its cost
If the capital losses exceed the capital gains, this excess portion will not reduce the CDA inclusions set out in last three points listed above.
Future capital losses will reduce your CDA balance, which means it is good planning to file the prescribed forms at your next corporate year end if you have realized a capital gain or have a surplus in your CDA account.
To make an election to file a capital dividend, your company must file prescribed form T2054 to the Canada Revenue Agency on or before the dividend becomes payable or was paid. The corporation must also submit additional information with the election, which includes:
• a certified directors’ resolution authorizing the election
• a schedule showing the calculation of the CDA immediately before the election
The CRA will generally accept the election if it is filed late, provided the appropriate interest and penalties are paid. The maximum penalty is $500 per year or $41.67 per month.
The CDA balance that is reported on your corporate tax return may not be correct if you’ve changed accountants more than once. It will also not be listed on the CRA’s My Business Account service.
The CRA can help verify your CDA calculations or schedule, but don’t expect to get them by phone. You must make the request in writing and include your own CDA calculations.
A CRA agent reminded me that it is the corporation’s responsibility, and not the agency’s, to be aware of what is in its CDA account. He also said the CRA can remove the CDA addition from the CDA calculation if the corporation cannot verify how it occurred.
It has been my experience that the CRA will identify any adjustments that might have been missed, both positive and negative, if we make an honest effort at a company’s CDA calculation or schedule.
If your farming company has made an election to pay you a capital dividend and you’ve overshot your available CDA balance, then the full amount of the capital dividend will be subject to a 60 percent penalty tax.
This penalty can be avoided if the corporation immediately makes appropriate income tax elections.
The CDA is a significant tax tool to corporate business owners.
In my accounting and tax practice, I have seen three recurring examples of how the CDA is especially effective:
• A cumulative cookie — This typically occurs when we begin winding down the farming company. For example, in our efforts to clean out the corporate pantry, we discover that our client’s farming company, which was incorporated in 1976, has a CDA balance of $35,000. Once the CDA balance was verified, we were able to distribute these funds to the retiring couple tax-free. They bought a trailer.
• Machinery magic — With machinery dealers offering exuberant trade-in values on farm equipment, any capital gain triggered on its disposition will increase the corporation’s available CDA. A machinery dealer will agree on a trade-in difference and inflate the purchase price and trade-in price to arrive at the same agreed trade-in difference. It is not unusual for some of these transactions to result in a capital gain for tax purposes. Last year, one of our client’s CDA balance increased by $72,000 as a result of a tractor trade in.
• The Oscar — In these situations, corporate farmland or quota is sold and in the process large notional deposits are added to the CDA account. These tax free distributions can be far more than $500,000. It’s definitely Oscar night.
In short, corporate business owners are quick to remember a tax-free corporate dividend from their CDA.
For this reason, these same business owners regularly review their CDA account to ensure that an old gain is not sitting there undistributed.
If there is a CDA balance, prudent business owners will file the prescribed forms promptly to the CRA. The capital dividends will be paid directly to the designated shareholders or applied to their shareholder loan account tax free. It simply makes tax free sense.