9.13 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.

  • Capital Dividends- Non-taxable portion of the capital gains which are paid out to the shareholders tax-free.

$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).

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Author: Anthony Au, January 2020

References and Resources


How are capital dividends treated for tax purposes? How does this tie into the concept of integration?” from Intermediate Canadian Tax Copyright © 2021 by Gurleen Kaur is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.