Income Tax Act (ITA) section 89(1)

The Capital Dividend Account (CDA) is a special notional tax account which a private corporation (CCPC) can use to give shareholders designated capital dividends tax-free. The CDA is not recorded in the corporation's accounting records or financial statements.

If an individual would receive a capital amount tax-free, a corporation can credit that amount to the CDA and transfer it to a shareholder tax-free (integration).

CDA Credits

The following get added to the CDA.

• capital dividends received from other CCPCs
• the tax-free portion of net capital gains realized since 1971
• the tax-free proceeds from the sale of eligible capital property (e.g., goodwill)
• life insurance death benefit less the ACB
  • the corporation does not need to be the policyowner but must be a beneficiary

Each category has a separate CDA credit

• a negative balance is carried forward, but does not reduce the CDA credit in other categories

Insurance CDA Credit

Insurance CDA Credit = Death Benefit - ACB

$Insurance CDA Credit = Death Benefit - ACB$ where $ACB = \sum Premium - \sum NCPI$

So the Insurance CDA Credit is only reduced by administration charges and premium tax

Exclusions

A corporation receives the following tax-free but they do not create CDA credits:

• disability benefits
• (likely) critical illness benefits
• lottery winnings

Using CDA Credits

As long as a corporation has CDA credits, the corporation can designate any dividend as a capital dividend

• can pay these capital dividends to Canadian resident shareholders on a prorata basis
• can defer payment for years

From a Life Insurance Death Benefit

The CDA credit can be paid to the shareholders immediately as a promissory note if no other cash is available

• effectively converts the CDA credit to a shareholder loan against which the shareholder can make tax-free draws at any time
• reduces the value of shares in the corporation for capital gains
  • the shareholder loan is not subject to capital gains tax upon death
  • but shares of a corporation with significant pre-existing CDA balance could have increased in value —> greater deemed disposition on the shareholder's death