One tool that owners of corporations can use to reduce their tax and the tax of their estates is the Capital Dividend Account (CDA). This often-underutilized account can be a game-changer, allowing you to pass on assets tax-efficiently.
What is the CDA?
The CDA is a provision in the Canadian Income Tax Act which allows some corporate surpluses to be distributed to shareholders or a shareholder’s estate tax-free. How does that work?
First, despite being called the Capital Dividend Account, the CDA is not a separate savings account. Rather it is a notational account that indicates capital assets have been received by your corporation and the amount you have claimed in the account to receive them tax free.
Normally income earned by a corporation and then distributed to shareholders is the same as if the shareholder earned the income directly. However, the corporation tracks the non-capital gains portions of assets it receives (i.e. with a life insurance benefit) in the Capital Dividend Account. These funds can then be passed on to the shareholder tax-free, as long as the corporation accounts for the adjusted cost base of those assets.
Generally, the CDA can track money received by your corporation through the sale of an asset, life insurance proceeds, or tax-free dividends. Paying too much out though, can cause penalties to be assessed.
CDA as an Estate Planning Tool
So, why is the CDA such a helpful estate planning tool? Here are a few strategies to consider:
Tax-Efficient Estate Transfer: When you pass away, the balance in your CDA can be distributed tax-free to your beneficiaries or heirs. This provides a tax-efficient way to transfer wealth. It’s important to note that not all assets in your corporation are eligible for this treatment, but the CDA allows you to preserve and pass on those that are.
Leveraging Life Insurance: A life insurance policy owned by the corporation over a shareholder can have the death benefit go to the corporation. If the adjusted cost base can be reduced to zero, the full death benefit can then be passed on to the shareholder, tax free.
Funding Legacy Wishes: If you have specific wishes for how your assets are used after your passing, the CDA can provide a tax-efficient mechanism to fund charitable donations, trusts for family members, or other legacy plans.
Complicated but Powerful
The CDA is a complicated, but powerful instrument. Its proper use generally requires that you work closely with tax professionals, estate lawyers, and financial advisors who have a deep understanding of Canadian tax laws and regulations. They can help you determine the eligibility of your corporate surpluses for the CDA and provide guidance on structuring your estate plan.
Leveraging the CDA allows you to pass on assets tax-efficiently to your loved ones, ensuring that your wealth is used as you intended, while minimizing the tax burden. To make the most of this opportunity, consult with experts who can help you navigate the intricacies of the CDA and create a customized estate plan tailored to your unique goals and circumstances.
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Disclaimer: This blog post is for informational purposes only and should not be construed as financial or legal advice. Consult with qualified professionals to create a personalized estate plan suitable for your specific circumstances.
