Capital dividend accounts offer Canadian private corporations a way to distribute tax-free dividends to their shareholders. There are many rules and regulations associated with these accounts, and it is not uncommon for corporations to find themselves offside, such as by inadvertently paying shareholders a capital dividend greater than the balance in the account. This article discusses the most common issues that arise when preparing capital dividend elections and explores some ways to remedy errors.
What is a capital dividend account?
A capital dividend account (CDA) tracks the non-taxable receipts of a private corporation that can be distributed as tax-free capital dividends to shareholders. It typically consists of the non-taxable portion of capital gains realized, the non-taxable portion of proceeds received under a life insurance policy, the capital dividends received from another corporation, and similar receipts.
A corporation’s CDA is a cumulative balance that aggregates specific types of income and capital transactions, and this balance can fluctuate during the year as a corporation realizes gains or losses.
As advisors, CPAs often help clients calculate their corporation’s CDA balance and prepare Form T2054 Election for a Capital Dividend Under Subsection 83(2), which must be filed with the Canada Revenue Agency (CRA) when a corporation declares a capital dividend.
Error: Excess capital dividend paid
A corporation’s CDA balance can become overstated due to incorrect calculations of amounts included in the account, the retroactive application of certain provisions of the Income Tax Act (the Act),1 and other factors.
If a corporation pays a capital dividend that exceeds its actual CDA balance, the corporation will be subject to Part III tax equal to 60% of the excess amount,2 and interest will accrue on any unpaid Part III tax from the date the election was made.3
This will have an impact on the dividend recipients as well. Although recipients of a capital dividend are not taxed on the entire dividend amount, shareholders who receive the excess capital dividend are liable for their proportionate share of the Part III tax.4
Remedy: Treating an excess capital dividend as a taxable dividend
If a corporation pays a capital dividend that exceeds the balance in the CDA, it can take corrective action by electing to treat the excess amount as a taxable dividend under subsection 184(3) of the Act. The corporation must follow specific rules, and the election5 must be made within 90 days of the issuance of a notice of assessment for Part III tax.6 Note: To avoid waiting for an assessment of Part III tax, the corporation can ask the CRA to use the direct assessment (or “short-cut”) method, whereby shareholders are directly assessed on the excess amount as a taxable dividend.
In addition, if the corporation elects to treat the excess amount as a taxable dividend, one of the following criteria must be met:
- The election must be made within 30 months of the date the original dividend became payable and with the agreement of every recipient shareholder whose address was known to the corporation; or
- All recipient shareholders must agree with the election. In this case, the CRA can assess tax, interest, and penalties payable on all recipient shareholders for any tax year as is necessary to take the corporation’s election into account (regardless of the normal three-year reassessment period).7
Given the criteria above, it is prudent to obtain the agreement of the dividend recipients before declaring a dividend, rather than seeking consent after the fact, when shareholders may be less willing to provide their approval.
The subsection 184(3) election may also include a late designation of a portion of the excess amount as an eligible dividend. A late designation can be made within three years of the date on which the original dividend was paid, where, in the opinion of the CRA, it would be just and equitable to permit such a designation.8
Consideration: Filing an objection and a protective 184(3) election
If the corporation disagrees with the CRA’s assessment of Part III tax, it can file a notice of objection. The objection must be filed within 90 days of the date of the Part III tax assessment.9
When filing an objection, the corporation should also consider filing an election under subsection 184(3) of the Act as a protective measure. This election must also be filed within 90 days of the Part III tax assessment date. As it is unlikely that an objection will be resolved before the 90-day deadline for a subsection 184(3) election, the CRA will suspend the election pending the outcome of the objection. If the objection is upheld, the subsection 184(3) election will be withdrawn and considered never to have been made. If the objection is dismissed, the subsection 184(3) election will be considered valid and having been made within the prescribed time frame.
Error: Insufficient capital dividend paid
Typically, if a corporation erroneously makes a capital dividend payment that is below the CDA balance, there will be no immediate adverse tax consequences to the corporation or the shareholders.
Remedy: Paying a second capital dividend
A second capital dividend can be paid to distribute the remaining CDA balance to shareholders as originally intended, as long as the shareholders on record when the first capital dividend was paid are the same ones on record when the make-up capital dividend is declared. However, if a shareholder disposes of their shares before the second dividend is declared, the corporation may not be able to use this option, as it cannot declare a dividend to a person who is no longer a shareholder. In this case, a rectification may be the only path to making the shareholder whole.
Error: Dividend resolutions do not reflect the intention
Sometimes, the resolution declaring and electing a capital dividend does not reflect the intention of a corporation’s directors. For example, if the directors decide to implement a plan that includes paying a capital dividend based on the CDA balance available at a particular time, but the resolutions are drafted such that the capital dividend is erroneously paid at a time when the CDA balance is lower than expected, the dividend would be declared in an amount greater than the CDA balance. A CDA election would then be filed on that basis.
In this type of situation, the option of treating the excess payment as a taxable dividend would still be available. However, the directors may prefer to avoid this option if, for example, the capital dividend is part of a broader tax plan.
Remedy: Rectifying or rescinding the resolution
The corporation could seek to rectify or rescind the capital dividend resolution. Although this option might remedy the excess capital dividend, it does come with its own set of disadvantages. Chief among them is the fact that rectifications and rescissions are court-ordered legal proceedings that typically require applicants to seek legal advice.
Error: Filing after the dividend is paid
A capital dividend election must be filed either by the day on which the dividend becomes payable or by the day on which any part of the dividend is paid—whichever is earlier. Not filing an election on time will result in a penalty.
Remedy: Paying a penalty
The election can be late filed, provided certain criteria are met. A late-filed election must be made using Form T2054,10 and a late-filing penalty must be paid when the election is filed. The penalty is calculated as the lesser of $41.67 or 1/12 of 1% of the capital dividend, multiplied by the number of months the election is late.11 As well, the directors (or persons legally entitled to administer the corporation’s affairs) must authorize the election before it is made.12
If the CRA has issued a written request to make a late-filed election, the payor corporation will have 90 days from the date of the request to file the election. After that time limit, the late filing option will no longer be available.13 Outside of these mechanisms, an election may only be filed late under the taxpayer relief provisions at the discretion of the CRA.
Final thoughts
Capital dividend accounts offer significant benefits for private corporations and their shareholders who want to benefit from tax-free capital dividends. However, errors in their use can be costly. It’s a good idea to consult with a qualified advisor to ensure you are accurately calculating the account balance and are following all documentation and filing requirements.
Kaiden McIntyre, CPA, is a senior manager in tax with Crowe MacKay in Vancouver, where he specializes in corporate and personal tax planning and compliance, including corporate reorganizations, estate and succession planning, and CRA dispute resolution.
This article was originally published in the September/October 2025 issue of CPABC in Focus.
Footnotes
1 R.S.C., 1985, c. 1 (5th Supp.), as amended.
2 Subsection 184(2) of the Act.
3 Subsection 185(2) of the Act.
4 Subsection 185(4) of the Act.
5 The prescribed requirements are detailed in section 2106 of Canada’s Income Tax Regulations. The CRA recently released Form T2184 Election to Treat an Excess Dividend as a Separate Dividend Under Subsection 184(3), which can be used to satisfy the prescribed requirements instead of filing a letter to the CRA.
6 Subsection 184(3) of the Act.
7 Subsection 184(4) of the Act.
8 Subsection 89(14.1) of the Act.
9 Subsection 165(1) of the Act.
10 The prescribed requirements are detailed in section 2101 of Canada’s Income Tax Regulations.
11 Subsection 83(4) of the Act.
12 Subsection 83(3) of the Act.
13 Subsection 83(3.1) of the Act.
