Table of Contents
What are Capital Dividends (Canada)?
Certain dividends, called capital dividends, may be paid tax-free by private corporations to their Canadian-resident shareholders. This means that no part of the dividend is included in the shareholder’s income.
For a corporation to pay a capital dividend, it must make an election to designate the entire amount of the dividend to be a capital dividend. The election is made by completing and filing Form T2054, Election for a Capital Dividend Under Subsection 83(2) with the Canada Revenue Agency (CRA) by the election due date.
What is the Capital Dividend Account (CDA)?
Canadian-controlled private corporations (CCPCs) track certain non-taxable income amounts in a notional account called the Capital Dividend Account (CDA), and are able to pay these amounts to shareholders as a capital dividend. The capital dividend is not taxable to the shareholder recipient.
The CDA tracks a private corporation’s tax-free surpluses. The CDA generally includes:
- the tax-free portion of capital gains realized by the corporation to the extent they exceed the non-deductible portion of the corporation’s capital losses;
- life insurance proceeds on certain policies; and
- capital dividends received from other corporations.
Capital dividends paid by a corporation reduce its CDA dollar for dollar.
Journal Entries for Capital Dividends (Canada)
Journal entry for capital dividends paid in cash
Where a capital dividend is paid to a shareholder in cash, the Cash account is credited for the full amount paid out, and the Retained Earnings account is debited. Capital dividends are a direct reduction to the Retained Earnings of a corporation.
Example: CanCo Inc. has declared and paid out a $2,000,000 capital dividend to its 100% shareholder, Mr. Smith.
| Account | ||
|---|---|---|
| Retained Earnings | $2,000,000 | |
| Cash | $2,000,000 |
Journal entry for capital dividends increasing the paid-up capital of shares
Where a capital dividend is paid to increase the legal stated capital and paid-up capital (PUC) of shares of the corporation, the Common Shares account is credited for the capital dividend amount, and the Retained Earnings account is debited. This often occurs in the context of an corporate reorganization.
Example: CanCo Inc. has declared a $2,000,000 capital dividend on its common shares, which will increase the paid-up capital of the common shares.
| Account | ||
|---|---|---|
| Retained Earnings | $2,000,000 | |
| Common Shares | $2,000,000 |
Journal entry for capital dividends paid by way of promissory note
Where a capital dividend is paid to a shareholder in the form of a promissory note, the Due to Shareholder account is credited for the full amount declared, and the Retained Earnings account is debited. Capital dividends are a direct reduction to the Retained Earnings of a corporation. The capital dividend has not been paid out in cash but is available for the shareholder to withdraw at any time they please.
Example: CanCo Inc. has declared and paid via promissory note, a $2,000,000 capital dividend to its 100% shareholder, Mr. Smith.
| Account | ||
|---|---|---|
| Retained Earnings | $2,000,000 | |
| Due to Shareholder | $2,000,000 |
