A corporation purports to pay a capital dividend, but a portion of the dividend is in excess of the balance of the corporation’s capital dividend account (CDA). The corporation pays Part III tax on the excess rather than elect under subsection 184(3) of the Income Tax Act (Canada). Is the corporation’s CDA balance reduced by the full amount of the dividend thereafter? The CRA takes the position that only the portion of the dividend that does not exceed the corporation’s CDA balance immediately before the dividend was paid reduces the CDA balance going forward.
The CRA notes that, as per the post-amble to subsection 89(1) “capital dividend account”, the CDA balance is reduced by “the total of all capital dividends that became payable by the corporation after the commencement of the period and before the particular time”. A capital dividend, however, is defined by paragraph 83(2)(a) to be the amount of the dividend paid for which an election is filed “to the extent of the corporation’s [CDA] immediately before the particular time.” According to the CRA, only that portion of the dividend is a capital dividend that grinds the payer’s CDA balance, even where the total amount of the dividend paid is in excess of the balance of the payer’s CDA.
The excess is still received tax-free by the recipient, if the recipient does not file an election under subsection 184(3). Paragraph 83(2)(b) provides that “no part of the dividend [for which an election has been filed] shall be included in computing the income of any shareholder of the corporation.” The paragraph does not state that only the capital dividend is received tax free.
Moreover, the full amount of the dividend, even the excess portion, is added to the CDA of a recipient corporation. See paragraph (b) of subsection 89(1) “capital dividend account”, which provides for the addition of “all amounts each of which is an amount in respect of a dividend received by the corporation on a share of the capital stock of another corporation in the period, which amount was, by virtue of subsection 83(2), not included in computing the income of the corporation”. Again, the provision does not state that only the capital dividend amount is added to the CDA of the recipient.
See CRA technical interpretation 2011-0417511E5 dated August 25, 2011 (French only).