CAPITAL DIVIDEND ACCOUNT OPTIMIZATION
To schedule an appointment, contact our law firm at 403-400-4092 or Chris@NeufeldLegal.com
A company can look to optimize its Capital Dividend Account (a notional tax account that tracks tax-free amounts) by strategically managing the generation and distribution of eligible non-taxable receipts. The capital dividend account's main purpose is to allow a Canadian-controlled private corporation to pay out certain accumulated surpluses to its shareholders as tax-free capital dividends. Optimization involves proactive planning to maximize the capital dividend account balance and ensure the timely and correct distribution of capital dividends to avoid significant penalties.
The cornerstone of capital dividend account optimization is maximizing the eligible deposits that increase its balance. The most common and significant source is the non-taxable portion of capital gains. Since only 50% of a capital gain is included in a corporation's taxable income, the other 50% is added to the capital dividend account. Companies should, therefore, focus on holding growth-oriented investments (like certain stocks, mutual funds, or exchange traded funds) within the corporation to generate capital appreciation. Another critical, often substantial, deposit is the proceeds of a life insurance policy received by the corporation upon the death of the insured, less the adjusted cost basis of the policy. Properly structured corporate-owned life insurance can provide a significant, tax-free boost to the capital dividend account for estate planning or buy/sell agreements.
Optimizing the capital dividend account requires careful timing of capital transactions, particularly when both gains and losses are involved. Since the non-deductible portion of a capital loss reduces the capital dividend account balance, it is generally prudent to pay out any available capital dividend before realizing capital losses. This strategy prevents the loss from eroding the available tax-free distribution amount. Conversely, the realization of capital gains should be timed to build a significant capital dividend account balance when a dividend distribution is desired. For companies with substantial unrealized gains in their investment portfolio, the liquidation of appreciated assets can be strategically planned to align with shareholders' need for tax-free cash, maximizing the benefit before a potential capital dividend account-reducing event occurs.
The corporate and legal complexities associated with more advanced capital dividend account arrangements can be seen with Capital Dividend Account Streaming, which involves using different classes of shares to pay capital dividends preferentially to Canadian resident shareholders, as non-residents are subject to withholding tax. Furthermore, in the event of major corporate transactions like an amalgamation or wind-up, ensuring the capital dividend account balance is correctly transferred or calculated is vital to maintain its value. Ultimately, coordination with knowledgeable tax / legal professionals to integrate capital dividend account planning with the shareholders' personal tax situations and the corporation's overall business objectives, such as aligning a distribution with a shareholder's temporary low-income year, is key to maximizing the tax-free value of a capital dividend account.
Our law firm strives to provide strategic tax-driven legal advice and direction to Calgary businesses looking to optimize their business structures and corporate transactions. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for your business' tax structuring and tax planning initiatives.
