Capital Dividend Account (CDA)

It is notional. No money sits in it. It is a running record kept for tax purposes of amounts a private corporation has received that were not taxable in its hands.

Several things credit it, including the non-taxable portion of capital gains. The one relevant here is the death benefit of a policy owned by the corporation.

The credit is the death benefit less the adjusted cost basis of the policy. Not the whole benefit. On a policy with a substantial remaining basis the credit is smaller than the amount received, and the difference stays in the corporation as taxable retained earnings.

What it enables is a capital dividend, which a shareholder receives without income tax. That is the mechanism behind most corporate-owned insurance planning in Canada.

It is the reason corporate-owned insurance is discussed at all. Without the credit, a corporation receiving a death benefit would hold taxable retained earnings and the shareholder would pay tax again on extracting them. The account removes the second layer on the credited portion.

And it is why the ownership structure has to be right at the outset. The credit arises in the entity that owns and is beneficiary of the contract. An arrangement that looked convenient at application can put the credit in the wrong place permanently.

The credit is confirmed rather than assumed. The Canada Revenue Agency will provide the balance of the account on request, and an accountant should obtain it before any capital dividend is declared, because paying in excess of the balance attracts a penalty tax on the excess.

It is worth modelling before the policy is arranged. The size of the eventual credit depends on the death benefit and on what the adjusted cost basis will have become by then, and both are estimable at the outset by somebody who does this work regularly.

Why the structure has to be right at the outset

The credit arises in whoever owns and is beneficiary of the contract. Where that is the corporation, the credit is corporate. Where a shareholder or family member was named for convenience at application, the credit does not arise there and a taxable shareholder benefit may.

Correcting it later is itself a disposition, so the fix carries its own tax and may be worse than the problem.

Which is why the ownership question is settled before the application is signed, by an accountant with the corporate structure in front of them, and not by an insurance advisor working alone.

What to confirm before declaring a dividend

The balance, obtained from the Canada Revenue Agency and not estimated.

The election, filed in the prescribed form and before the dividend is paid.

The excess, because paying more than the balance attracts a penalty tax on the excess portion.

And the timing, because other transactions in the same period can affect the account and change what is available.

Why the account exists at all

The Capital Dividend Account is a record, not a bank account. Nothing is deposited into it and nothing is held in it. It is a running tally the corporation keeps of amounts that have already been taxed once, or that the Act treats as not taxable at the corporate level, so that paying them out to a shareholder does not tax them a second time.

This is the part worth understanding properly. That is the whole purpose: to avoid taxing the same dollar twice. It is not a loophole, nor a planning trick. It is the mechanism the Act uses to keep a corporation's shareholders in roughly the position they would have been in had they received the amount personally, and it works only when the balance is verified and the election is filed correctly and on time. None of it removes the contract's own constraints: a corporate-owned policy is measured against the exempt test every year exactly as a personally owned one is.

How the size of the credit changes over time

Because it is calculated on the excess. The credit is the death benefit less the adjusted cost basis of the contract, and that basis moves across the whole life of the policy.

Early in the life of a contract the basis is high, so the credit is smaller than the death benefit received. The difference stays in the corporation as taxable retained earnings a shareholder still has to extract in a taxed form.

Later the basis declines and the credit approaches the whole benefit. It is one of the few places in this subject where time works in favour of the structure and not against it.

Which means the credit cannot be assumed from the amount insured. Two corporations holding contracts of the same face amount can receive very different credits depending on how old each contract is, which is why the figure is modelled before the policy is arranged and not estimated afterwards. Where the contract is participating, the death benefit itself grows with the dividend scale, which is declared annually at the insurer's discretion and is not guaranteed.

One practical consequence follows from all of this, and it is the reason the account is worth understanding and not delegating. The balance is not reported to the corporation by anyone. It is tracked by the accountant, from the corporation's own records, and a balance nobody has tracked is discovered at the worst possible time: after a death, when the family is trying to move money out of a company and needs to know what may leave without tax. Ask what the balance is while there is still time to correct the record.

Who tracks the balance, and who should

The corporation tracks it, and nobody else does. The Canada Revenue Agency will confirm a balance on request, and a corporation is entitled to ask for that confirmation, but the agency is not the record keeper and does not send a statement. The running total is assembled by whoever prepares the corporate returns, from the transactions that added to it and the elections that drew on it, and it is only as good as the file behind it.

A change of accountant is where the record most often breaks. The balance travels in working papers and not in the financial statements, so a firm taking over a file inherits the number only if the previous firm passed it on. Where it was not passed on, it is rebuilt from the corporation's history, which is possible and expensive and sometimes incomplete.

Ask for the figure once a year, at the same time as the financial statements, and keep the confirmation with them. A number confirmed annually costs nothing to maintain. A number reconstructed after a death costs whatever the reconstruction costs, and it is reconstructed at the moment when the family has the least patience for it. Now you decide.