Understand the Capital Dividend Account

Incorporated small business owners may be able to take tax-free cash out of their corporation through the capital dividend account.

A capital dividend is one type of dividend that can be paid to shareholders of private corporations. Canadian residents can receive capital dividends on a tax-free basis.

What is the capital dividend account?

The capital dividend account is where we as your accountants keep track of tax-free revenue received by your corporation.

The types of revenue that increase the capital dividend account balance include:

• The non-taxable portion of capital gains realized on the sale of assets and investments
• The proceeds of a life insurance policy paid out on death to your corporation as a beneficiary
• Capital dividends received from other private corporations

 The most common of these three types of revenue is going to be capital gains.

In Canada, capital gains are 50% taxable and 50% non-taxable so corporations that buy and sell assets and realize capital gains on the sale of those assets are going to generate a balance in their capital dividend account.

The balance of your capital dividend account is tracked every year when you file your corporate income tax return on schedule 89 of the return.

The balance in your capital dividend account is reduced when you do one of the following:

• Pay a capital dividend from your corporation. Payment of a capital dividend reduces the value of the capital dividend account on a dollar-for-dollar basis; or
• Sell assets owned by your corporation for a loss. Realizing a loss on the sale of property (I.e., assets, investments) will reduce the capital dividend account balance by 50% of the value of the loss.

How do you confirm the balance in your Capital Dividend Account?

It is important to verify the balance available in the capital dividend account before a corporation pays a capital dividend to its shareholders.

If capital dividends are paid in excess of the balance available Canada Revenue Agency can assess a tax penalty of 60% of the excess dividend paid to shareholders.

The balance of the capital dividend account cannot be found in a company’s financial statements. Typically, this balance can be seen on Schedule 89 of your corporate income tax return.

However, due to the severe penalties involved in paying an excessive capital dividend we recommend that the account balance be verified with Canada Revenue Agency prior to paying a capital dividend from the corporation.

Talk to one of our accounts to have a request prepared to confirm the capital dividend account balance with Canada Revenue Agency.

How to pay a Capital Dividend to corporate shareholders

To pay a capital dividend, a corporation must file a special election with Canada Revenue Agency on or before the date the dividend becomes payable or when any part of the dividend is paid.

The special election is Form T2054 Election for a Capital Dividend Under Subsection 83(2) of the Income Tax Act. This election gets filed independently from your corporate income tax return.

T2054 must be accompanied by a certified copy of a special resolution of the directors of your corporation authorizing the election to be made. 

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Paying a capital dividend from your corporation presents a significant opportunity to withdraw non-taxable cash from your corporation, but because of the complexity of the election and the significant penalties triggered by a potential error you should speak to an accountant to file the election for you.