The capital dividend account of a corporation (“CDA”) is defined in subsection 89(1) of the Income Tax Act (Canada), and the definition requires that the balance of the account be calculated using something like the following formula:
A + B + C + D + E + F + G – H
In this formula, A, very roughly, is the total of the non-taxable portion of all capital gains realized by a corporation less itsthe total of the non-allowable portion of all capital losses. B is the total of all capital dividends received by the corporation. D is the total of all proceeds received from life insurance policies. H is the total of all capital dividends paid by the corporation before that time, and so on.
In calculating CDA, one must account for all events occurring from the beginning of the calculation period until its end cumulatively. In addition, while in the formula above ‘A’ cannot be a negative number, that doesn’t mean that capital losses can’t have effects on other components of the formula.
For example, suppose that in the calculation period Holdco realizes net capital losses of $1,000 and receives a $500 capital dividend from another corporation. Holdco, even though it has net losses, can still pay a dividend of $500 from its CDA. On the other hand, if Holdco first realizes a $1,000 capital gain, then pays a $500 capital dividend, then realizes a $2,000 capital loss and finally receives a capital dividend of $500, it will not be entitled to pay another amount from its CDA immediately thereafter. In the formula, A is nil (and it will remain at nil until more gains are realized to offset the losses), B is $500 and H is $500. The CDA balance, then, is nil.
These results aren’t always intuitive, and so, when engaging in CDA planning, it is sometimes necessary to map out carefully the components that make up the balance of a corporation’s CDA to determine what can actually be paid from the account.
One of my readers has written to point out that my summary of the CDA formula might leave one with the impression that the total proceeds from a policy will be added to CDA. This is incorrect, of course: it is the difference between the death benefit and the ‘adjusted cost basis’ (not ‘adjusted cost base’) that is added to a corporation’s CDA.