Life and Health Insurance

Five (5) questions about Capital Dividend Accounts (CDA)

WHAT IS A CDA?

A CDA is an account that tracks tax-free amounts accumulated by a private company. The company can then distribute a tax-free dividend to its shareholders residing in Canada. A CDA is a notional account that only exists for taxation purposes, which means it doesn't appear on a company's balance sheets.

 

WHAT AMOUNTS MAY BE INCLUDED IN THE CDA?

• The non-taxable portions of capital gains that exceed the deductible for capital losses
• The capital dividends received by the company
• The non-taxable portions stemming from disposition of an eligible capital property
• The total proceeds of a life insurance policy minus the adjusted cost basis (ACB) of the policy

 

HOW DO WE CALCULATE THE PORTION OF A CDA IN A LIFE INSURANCE POLICY?

The life insurance benefit received by the company as beneficiary or policyholder

Minus

The adjusted cost basis of the policy for the company immediately prior to death The ACB is basically the cost of the policy. In general, the ACB is equal to the sum of the premiums paid minus the annual net cost of pure insurance (NCPI). NCPIs are deducted every year from the policy and calculated using the appropriate prescribed mortality table.

Example:

Insurance amount = $500,000

Beneficiary: XYZ (a private company)

ACB at time of death: $100,000

Upon the death of the insured, XYZ will receive $500,000. Of this amount, $400,000 (Insurance Amount – ACB = $500,000 - $100,000) can be included in the CDA.

 

WHAT IS THE PURPOSE OF COMBINING A CDA AND A LIFE INSURANCE POLICY?

Life insurance policy proceeds are often used by companies and their shareholders to buy back shares upon the death of one of their own. The CDA makes it easier to optimize the taxation of the transaction.

 

WHEN AND HOW CAN THE COMPANY PAY OUT A CAPITAL DIVIDEND?

The company can declare the payment of a capital dividend when the CDA has a positive balance. Several events are likely to diminish and even reduce the balance of the CDC to zero, such as a realized capital loss or the conversion of a private company into a public company. Since a CDA’s balance cannot be negative, it may be a good idea for the company to pay a capital dividend before an event such as the aforementioned occurs.

When paying out the dividend, the company must file an election in prescribed form with the CRA as per the Income Tax Act and do so within a strict deadline.

 

For more information on CDAs, please talk to your tax professional.