55 How are capital dividends treated for tax purposes? How does this tie into the concept of integration?
Gurleen Kaur
The Capital Dividends are tax-free dividends that are paid out to the shareholders of the corporation as a form of return on investment. The tax-free surpluses of the corporations are accumulated in the capital dividend account (CDA). The balance in CDA is also increased by Capital dividends received.
A corporation can issue capital dividends up to the amount in the capital dividend account. For example, Breeze Co. has a capital gain of $52,000. One-half of this gain would be a taxable capital gain i.e. $52,000 x 50%= $26,000, and the other half ($26,000) is the non-taxable portion of the capital gain which goes into the CDA account.
Capital Dividends and Integration:
The goal of tax integration is that an individual should have the same amount of after-tax cash regardless of whether the income was earned directly or through a corporation. Since capital dividends are tax-free dividends, the tax rate at the corporate level and individual level is the same (i.e. they are tax free).
The table below illustrates the concept of tax-free dividends tied with integration. For Breeze Co., half of the capital gain i.e. the non-taxable portion, is paid out to the corporation’s shareholders tax-free resulting in the pre-tax earnings amount to be the same as the post-tax amount (at Corporate level). Similarly, at the individual level, since the capital dividends are paid out tax-free, when the dividends are received by the shareholders, both the pre-tax and post-tax amounts are the same. Hence, the net earnings paid out at the corporate level and individual level is the same, eliminating the problem of double taxation.
|
$52,000 X 50% =$26,000 |
|
CORPORATION |
|
|
Capital Dividend paid-out |
$26,000 |
|
Less: Corporate Tax (Capital dividends are Tax-free) |
$ – |
|
Net earnings |
$26,000 |
|
|
|
|
INDIVIDUAL SHAREHOLDER |
|
|
Capital Dividends received |
$26,000 |
|
Less: Individual Income Tax (Capital dividends are Tax-free) |
$ – |
|
Net earnings |
$26,000 |
So, in the example above, the shareholder would receive a capital dividend and after tax cash of $26,000 (on the non-taxable portion of the capital gain). This is the same amount of after tax cash the individual would have received if the taxable capital gain was taxed directly (and not through a corporation).
Interactive content (Author: Anthony Au, January 2020)
References and Resources:
- Article- “Income Tax Folio S3-F2-C1, Capital Dividends” (Author: Government of Canada)
- ITA 89(1) capital dividend account (a)
January 2020
