Capital Dividend Account: How to Pay Yourself Tax Free Dividends

What a Capital Dividend Account Is, and Which Corporations Have One

There is one way to take money out of your corporation without paying a cent of personal tax on it, and most owners either do not know it exists or find out about it years too late. It is called the capital dividend account. The CDA is a notional account. It is not on your balance sheet and there is no bank account behind it. It is a running tally the Income Tax Act keeps of amounts your corporation received that were never taxed, and it lets you push those amounts out to shareholders completely tax free, provided you file the election before you pay.

Only a private corporation resident in Canada can pay a capital dividend. Public companies cannot, even if they built a balance while private. The logic is simple integration. When your company realises a $200,000 capital gain, only half is taxed. The other half was never taxed at the corporate level, so the Act lets that untaxed half flow to you personally without tax. Without the CDA, you would pay corporate tax on half and then personal dividend tax on all of it, which is the comparison our guide to salary versus dividends in Canada sets out in full.  

What Goes Into the CDA: The Four Main Additions

Two things to keep straight. Capital losses reduce the account, and they do so as they are realised, so a strong year followed by a bad one can wipe out room you thought you had. And the balance is calculated at a point in time, not at year end, which matters more than almost anything else in this article. If the underlying gain came from a property sale, the mechanics of capital gains tax when selling a rental or second property determine how much room you actually created.  

Worked Example: How a $200,000 Capital Gain Creates CDA Room

Your corporation sells a rental property and realises a capital gain of $200,000.

The corporation pays tax on the $100,000 taxable half at its investment income rate. The other $100,000 sits in the CDA. You file the election, pay yourself a $100,000 capital dividend, and it arrives in your personal account with no tax and nothing to report as income. Compare that with taking the same $100,000 as an ordinary dividend. Depending on your bracket in BC, personal tax on a non eligible dividend can take a large bite. The CDA route keeps all of it.

Now add the timing trap. Suppose two months later the corporation realises a $60,000 capital loss. Half of that, $30,000, reduces the CDA. If you had already elected on the full $100,000, you are fine, because the balance is tested when you elect. If you wait, your room drops to $70,000. Paying capital dividends promptly after a gain is usually better than waiting.  

Life Insurance Proceeds Minus Adjusted Cost Basis

Corporate owned life insurance is the second big feeder, and it is why so many succession plans are built around it. When the insured shareholder dies and the corporation receives the death benefit, the CDA is increased by the proceeds less the policy’s adjusted cost basis. Two practical notes. Term policies typically have a low or nil ACB, so nearly the whole benefit creates CDA room. Permanent policies build ACB in the early years and then decline, so the timing affects how much room results. Also, the corporation should generally be both owner and beneficiary.

Naming a different corporation in the group as beneficiary while another pays the premiums is a classic structuring error that can strand the CDA credit in the wrong entity. Where the shareholder has died, the capital dividend usually has to be sequenced against the final tax return for a deceased person, so the estate and the corporation are not working from different numbers.  

How to Confirm Your CDA Balance With CRA Before You Pay

Do not rely on your own spreadsheet. CRA maintains its own figure, and it is the one that counts if you are reassessed. You have two ways to check. Your CRA My Business Account shows a CDA balance, and you can request a formal verification using Schedule 89, Request for Capital Dividend Account Balance Verification. The verification takes time, so build it into your planning rather than requesting it the week you want to pay.

Where the two figures differ, the usual causes are missed prior year gains and losses, a capital dividend received that was never recorded, or an older transaction that was reported differently than you remember. Reconciling before you elect is far cheaper than fixing it afterwards, and it is one of the reasons CRA record keeping requirements matter for a corporation that has held investments for years.  

Paying a Capital Dividend: Form T2054, Resolutions and Timing

The sequence matters, and the deadline is unusually tight.

1. Compute the balance immediately before the dividend, supported by a schedule.
2. Directors’ resolution declaring the dividend as a capital dividend and electing under subsection 83(2).
3. File Form T2054 with a certified copy of the resolution and the CDA calculation schedule.
4. Then pay it.

The election is due on or before the earlier of the day the dividend becomes payable and the first day any part of it is paid. That is not the T2 deadline. If you declare a dividend payable on March 1 and file the election in June with the corporate return, it is late. Step 2 is also the one that goes missing years later. A dividend recorded in your accounting software but never documented by resolution is a standard finding in due diligence, which is why the corporate minute book should be updated in the same week, not the same decade.

Late filing is not fatal. There is a mechanism to file late with a penalty, but it requires the corporation to be in a position to elect and the penalty is based on the amount and how late you are. Filing on time is much simpler.  

Overpaying a Capital Dividend: Part III Tax and the Election to Fix It

If you elect on more than the balance, the corporation faces Part III tax at 60% of the excess, plus interest. Shareholders can be jointly liable for their share. This is one of the harshest penalties in the Act, which is why the verification step above is worth the wait. There is a relief valve. An election under subsection 184(3) lets the excess be treated as a separate taxable dividend to the shareholders instead of attracting Part III tax. It generally requires the agreement of the affected shareholders and has its own timing rules, so it is a fix rather than a plan.  

When a Capital Dividend Is, and Isn’t, the Right Move

Good reasons to pay one now

• You have just realised a gain and want the room out before future losses reduce it
• You need personal cash and the alternative is a taxable dividend or salary
• You are preparing for a sale or reorganisation where the balance could be lost
• The corporation received life insurance proceeds

Reasons to pause

• The money is genuinely better left invested in the corporation
• Your balance is uncertain and you have not verified it with CRA
• A capital loss is likely before year end and you have not modelled the effect
• There are multiple shareholders, since capital dividends must be paid on a class of shares and everyone holding that class shares in it

That last point catches family corporations. If the class you are electing on is held by several people, you cannot direct the dividend to just one of them. Share structure has to support the plan. The CDA also does not sit on its own. A well planned distribution year usually pays capital dividends first because they cost nothing, then eligible dividends to the extent of GRIP, then non eligible dividends sized to release the refund tracked in your RDTOH pool. And where the room came from selling the business itself, the choice between an asset sale and a share sale is what created or destroyed it. Getting the balance right, on the right date, with the election filed on time, is the whole job.

Maxpro Financials verifies CDA balances with CRA and prepares the T2054 package for owner managed corporations across BC, so the room you think you have is the room you actually have.

FAQ: Capital Dividend Accounts in Canada

Is a capital dividend really completely tax free?

For the shareholder receiving it, yes. It is not included in income and does not appear on your T1. The corporation already bore tax on the taxable half of the underlying gain.

Can a sole proprietorship or partnership have a CDA?

No. It is only available to private corporations.  

Do I report a capital dividend on my personal tax return?

No. It is not taxable income. Your corporation reports the election on Form T2054.  

What happens if my CDA balance is negative?

You simply cannot pay a capital dividend until later gains bring it back above zero. A negative balance is not a tax bill on its own.  

Can I pay a capital dividend and a regular dividend in the same year?

Yes. They are separate declarations and separate resolutions. Keep the paperwork distinct so the capital dividend is clearly identified.  

How long does CRA take to verify a balance?

Plan for several weeks or longer. Request it before you need it, not after you have declared the dividend.  

Does a capital dividend affect my RDTOH or dividend refund?

No. Capital dividends do not generate a dividend refund. Only taxable dividends do.  

What if my accountant has never tracked our CDA?

It can be reconstructed from prior returns and transaction history, but it is detailed work. Do it before you plan to pay, not after.  

Can the CDA be used to strip value before a sale?

It is commonly used in pre sale planning, but it interacts with anti avoidance rules and share sale mechanics. Model it as part of the sale plan rather than as a standalone move.  

Does life insurance owned personally create CDA room?

No. The corporation must own and receive the proceeds. Personally owned insurance pays out tax free to you directly but adds nothing to the CDA.  

Have Us Verify Your CDA Balance Before Your Next Dividend