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The CDA and Life Insurance - Tips and Traps

March 28, 2006

The Capital Dividend Account (CDA) mechanism reflects a fundamental principle of the Canadian income tax system - integration. Taxes paid by a person should be the same whether income is earned personally, or earned by a corporation and then distributed to the person. The CDA plays an important role in achieving the goal of integration.CALU thanks members Sandra Bussey and Lea Koivfor taking the time to share this article concerningthe Capital Dividend Account (CDA)and Life Insurance.

Paul McKay, Executive Director - CALU

Table Of Contents

Introduction

The Capital Dividend Account (CDA) mechanism is an extremely important tax planning tool for private corporations and their Canadian shareholders. A fundamental principle of the Canadian income tax system is "integration." With integration, the taxes paid by a person should be the same whether income is earned by him or her personally, or is earned by a corporation and then distributed to him or her. There are instances where income received personally is either tax-exempt or tax-preferred. The CDA allows similar income earned by a corporation to be distributed to the shareholder tax-free to achieve integration.

While the CDA mechanism is generally well-understood, there are some details which warrant highlighting. It is appropriate that anyone giving advice with respect to the CDA calculations be aware of these. Hence, this article on "Tips and Traps."

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General Discussion

The CDA is defined in subsection 89(1) of the Income Tax Act[1]. It is a notional tax account that tracks various tax-free amounts accumulated by a private corporation. Such accumulated amounts may be distributed to a corporation's Canadian-resident shareholders on a tax-free basis.

The CDA is comprised of the following components, as set out in the definition of the CDA in subsection 89(1) of the Act:

The sum of:

  • The cumulative excess of the non-taxable portion of capital gains over the non-deductible portion of capital losses incurred by the corporation since 1971 (or since it last became a private corporation);
  • Capital dividends received from other corporations;
  • The non-taxable portion of gains from the disposition of eligible capital property such as goodwill or customer lists;
  • Life insurance death proceeds received by the corporation less the adjusted cost basis (ACB) of the policy to the corporation; and
  • Certain distributions made by a trust and received by the corporation in respect of non-taxable capital gains realized by the trust, and capital dividends received by the trust;

Less

  • The total of all capital dividends previously paid by the corporation to its shareholders.

Although the components appear relatively straightforward, care should be taken when calculating the balance in the CDA. It is also important to realize that whenever the payment of a capital dividend is contemplated, the balance of the CDA must be calculated, taking into account additions and deductions from the inception of the account. Errors can be made where the balance is calculated on a "carry-forward basis" (i.e., by simply taking the balance as at the date a dividend was last paid and adjusting this balance for subsequent transactions). (See the discussion under "Capital Dividend Account Trap.")

Capital gains inclusion rates have changed over time. Also, there have been recent changes in timing issues relating to the inclusion of gains from the disposition of eligible capital property.[2]Professional advice should be sought to ensure accurate calculation of the balances. It is also essential that the appropriate elections be filed in a timely manner. (See the discussion under "Electing to Pay a Capital Dividend.")

Changes in a corporation's status or control (e.g., a private corporation becomes a public corporation because it becomes controlled by the public corporation) may adversely impact the ability to pay Capital Dividends. It is essential that professional advice be obtained in these circumstances.

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Capital Dividend Account Trap

As noted above, the CDA is comprised of several different components. In calculating the balance in the CDA at a particular time, the amount of each component is computed on a cumulative basis for a particular period. The period starts on the first day of the first taxation year ending after 1971 and after the corporation last became a private corporation and ends immediately before the balance in the CDA is to be determined.

For example, a private corporation was incorporated on Jan. 1, 2000, and paid a capital dividend on June 30, 2004, and March 31, 2005. For purposes of calculating the CDA balance for the June 30, 2004, election, the period would be from Jan. 1, 2000, to immediately before June 30, 2004. For purposes of calculating the CDA balance for the March 31, 2005, election, the period would be from Jan. 1, 2000, to immediately before March 31, 2005.

For that reason, calculating the CDA balance on a "carry-forward basis" should not be used as errors could be made in the calculation. For example, assume a private corporation was incorporated on Jan. 1, 2000, and has a Dec. 31 year-end. In the 2002 taxation year, the corporation realized a capital loss of $100,000 and in the 2004 taxation year it received a capital dividend from another corporation of $200,000. On Jan. 30, 2005, the corporation paid out a capital dividend of $200,000 to its shareholders. The calculation of the CDA balance was done as follows:

Excess of non-taxable portion of capital gains over non-deductible portion of capital losses (must be positive amount):

2002 taxation year ($50,000) Nil

Capital dividends received from other corporations $200,000

Capital dividend account immediately before Jan. 30, 2005 $200,000

Less: Capital dividend paid on Jan. 30, 2005 (200,000)

CDA balance forward $ -

Assume that in the 2005 taxation year and after Jan. 30, 2005, the corporation realized a $60,000 capital gain and on Jan. 30, 2006, the corporation would like to pay out a further capital dividend.

If the "carry-forward basis" were used for calculating the CDA, the result would be a CDA balance of $30,000 being:

CDA balance forward from Jan. 30, 2005 $ -

Excess of non-taxable portion of capital gains over
non-deductible portion of capital losses

2005 taxation year$30,000 $30,000

Capital dividend account immediately before Jan. 30, 2006 $30,000

However, in actual fact, there would be no balance in the CDA at Jan. 30, 2006. The calculation of the CDA balance at Jan. 30, 2006, should have been done as follows:

Excess of non-taxable portion of capital gains over non-deductible portion of capital losses:

2002 taxation year($50,000)
2005 taxation year $30,000$ -

Capital dividends received from other corporations $200,000
Less: Capital dividends previously paid ( 200,000)

Capital dividend account immediately before Jan. 30, 2006 $ -

It is generally thought that when a capital dividend is received from another corporation or an amount is received in respect of life insurance death proceeds and credited to the CDA, the full amount of these items can be paid out as a capital dividend. However, there are situations where this may not be the case.

For example, assume a private corporation is incorporated on Jan. 1, 2000, and has a Dec. 31 year-end. In the 2002 taxation year, the corporation realized a capital gain of $700,000 and on Jan. 1, 2003, paid out a capital dividend of $350,000 to its shareholders. In the 2003 taxation year and after Jan. 1, 2003, the corporation realized a capital loss of $600,000 and in the 2005 taxation year received life insurance death proceeds of $500,000 (assume the ACB of the policy was nil). The corporation would like to pay out a capital dividend on Jan. 30, 2006, of $500,000. However, the balance in the CDA will be less than $500,000 as calculated below:

Excess of non-taxable portion of capital gains over non-deductible portion of capital losses:

2002 taxation year $350,000
2003 taxation year (300,000) $ 50,000

Life insurance death proceeds less ACB of the policy $500,000
Less: Capital dividends previously paid (350,000)

Capital dividend account immediately before Jan. 30, 2006 $200,000

The balance of the life insurance death proceeds of $300,000 will only be able to be paid out as a capital dividend after the corporation realizes net capital gains of $600,000 subsequent to Jan. 30, 2006.

The above examples highlight the importance of calculating the CDA balance using a cumulative calculation starting with the first day of the first taxation year ending after 1971 and after the corporation last became a private corporation and ending immediately before the balance in the CDA is to be determined. Using any other method could result in the payment of a capital dividend in excess of the actual CDA balance. (See the discussion under "Capital Dividends in Excess of the CDA Balance.")

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Life Insurance Proceeds and the Impact on the CDA

The fact that all or part of life insurance proceeds (depending upon the ACB of the insurance contract at the time of death) paid to a private corporation upon the death of a person is added to the CDA is a significant tax advantage that life insurance products enjoy. The Canada Revenue Agency (CRA) has stated:

"The capital dividend account is part of the system for integrating the corporate and shareholder income tax of private corporations and is intended to preserve the character of non-taxable receipts (such as the proceeds of certain life insurance policies) of a corporation in the hands of its shareholders."[3]

Where the ACB of the contract is nil, 100% of the life insurance proceeds would be credited to the CDA. In this case, the individual shareholder will be in the same situation as he or she would have been had they received the death benefit directly.[4] However, where the ACB is greater than zero, only the portion of the life insurance proceeds in excess of the ACB may flow via the CDA account. Since the amount equal to the ACB will generally be paid out as a taxable dividend, the shareholder will retain less of the death benefit because of the taxes due on the taxable dividend than he or she would have had the life insurance proceeds been received directly. From a practical perspective, if the insured lives to normal life expectancy the ACB is often minimal or even nil. Hence, the shareholder may indeed be able to receive the entire life insurance proceeds tax free.

The ACB of a life insurance contract is defined in, and calculated in accordance with, subsection 148(9). Generally, the ACB of a policy is equal to the total deposits made into the policy less the sum of the net cost of pure insurance (NCPI) (the NCPI is only deducted for policies last acquired after Dec. 1, 1982).

There are other factors that decrease and increase the ACB. For example, partial dispositions, taking a policy loan,[5] and the payment of dividends under a participating contract will decrease the ACB; whereas, the repayment of a policy loan, previously taxed gains, the purchase of paid-up insurance, and the purchase of term insurance riders, attached to the underlying contract, will increase the ACB.

There may be situations where a corporation is the beneficiary under a policy issued by a non-resident insurer that does not operate an insurance business in Canada. This situation could arise where a private corporation that is resident in Canada has a non-resident shareholder. It is CRA's view that where the policy is a "life insurance policy" within the meaning of the Act, the CDA may be credited with the excess of the life insurance proceeds received at death over the ACB of the policy. The corporation is itself responsible for calculating the ACB.[6]

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Net Cost of Pure Insurance

NCPI is essentially the pure insurance costs under the contract each year. The Canadian Institute of Actuaries established the tables for determining[7] the NCPI rates in 1982 at the request of the Department of Finance. While all insurers use these same NCPI rates, there may in some instances be differences in interpretation and application of these rates. For example, insurers may differ as to whether "ultimate" or "select" rates are used once the life insured attains age 71. There may also be differences in how substandard risks are treated and in the determination of the equivalent single life age with joint (first or last-to-die) policies.

Since the approved NCPI tables do not show rates that are to be used once the insured attains age 71, it is CRA's view that insurers may calculate NCPI by extrapolating from the tables. The insurer's actuaries must, however, use methods that are reflective of accepted actuarial practices and the method must be employed consistently across all the company's policies of the particular class for which such extrapolation is necessary.[8]

Professional advisors should make enquiries as to how an insurer is calculating the NCPI, so as to ensure that they understand the impact on the CDA. Where, for example, NCPI charges are significant, this may be beneficial for a corporate beneficiary because the credit to the CDA will be maximized. It may, however, be inappropriate for an individual shareholder, as taxes relating to policy gains arising from full or partial policy surrenders may be magnified.

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Impact on CDA of Policies Acquired before 1982

While unusual, it is possible for the ACB of a life insurance policy to exceed the death benefit. As stated above, for policies acquired before Dec. 2, 1982, the ACB is computed without an NCPI grind. If such a policy has been outstanding for a long period of time, the total premiums paid, and hence the ACB, can exceed the death benefit.

Consequently, the issue arises as to how the credit to the CDA is calculated when a private corporation owns one or more life insurance policies on the life of a shareholder, and the ACB of one of the policies exceeds the policy death benefit.

When we look at paragraph (d) of the definition of CDA in subsection 89(1), we see it reads as follows:

(d) the amount, if any, by which the total of:

(i) all amounts each of which is the proceeds of a life insurance policy of which the corporation was a beneficiary on or before June 28, 1982, received by the corporation in the period and after 1971 in consequence of the death of any person,

(ii) all amounts each of which is the proceeds of a life insurance policy of which the corporation was not a beneficiary on or before June 28, 1982, received by the corporation in the period and after May 23, 1985, in consequence of the death of any person,

exceeds the total of all amounts each of which is the adjusted cost basis (within the meaning assigned by subsection 148(9)) of a policy referred to in subparagraph (i) or (ii) to the corporation immediately before that person's death.

Again, the period referred to in paragraph (d) is generally the period throughout which the corporation has existed (excluding taxation years ending before 1972) up to the time at which the CDA is being determined.

If the corporation owns a single policy on the life of the shareholder and it is the first policy under which the corporation receives proceeds, the result on the shareholder's death is straightforward. Paragraph (d) above provides that the amount added to the corporation's CDA is the amount, if any, by which the policy proceeds exceed the ACB of the policy. Since the proceeds do not exceed the ACB, this amount is nil, and so no amount is added to the CDA. However, as explained below, there may be adverse consequences for the calculation of the corporation's CDA in the future.

The situation is more complex if the corporation owns two or more policies on the life of the shareholder, or if it has previously received proceeds under policies on other lives.

Consider the scenario where the corporation owns three life insurance policies on the life of the shareholder. The policies have the following attributes when the shareholder dies:

 

Proceeds

ACB

Policy 1

100,000

155,000

Policy 2

125,000

35,000

Policy 3

110,000

45,000

There are two different views as to how the credit to the CDA should be computed in this scenario:

Aggregation basis

Determine the total proceeds under all the policies, and the total ACB of all the policies. The CDA credit is the excess of total proceeds over total ACB.

 

Proceeds

ACB

CDA Credit

Policy 1

100,000

155,000

-

Policy 2

125,000

35,000

-

Policy 3

110,000

45,000

-

Total

335,000

235,000

100,000

Policy-by-policy basis

Determine the CDA credit separately for each policy (proceeds minus ACB, nil if the proceeds are less than the ACB). The CDA credit is the total the policy-specific credits.

Proceeds ACB CDA Credit

Policy 1 100,000 155,000 0

Policy 2 125,000 35,000 90,000

Policy 3 110,000 45,000 65,000

Total: 155,000

The general view is that the first approach Ð the aggregation method Ð is correct. The language in the definition of CDA seems clear in this regard. It requires two total amounts to be determined: the total of all proceeds received by the corporation; and the total of the ACB of each policy under which the corporation has received proceeds. It then requires a calculation of the excess of the first total over the second total.

Accordingly where a corporation holds multiple policies on the life of a shareholder, and the ACB of one of the policies is greater than the policy death benefit, there will be a detrimental effect on the total amount credited to the corporation's CDA.

Care should be taken where a death benefit is received from a policy that was acquired before Dec. 2, 1982. The CDA will be miscalculated where the aggregation method is not used where it should be.

Where a corporation owns a pre-Dec. 2, 1982, policy with an ACB larger than the death benefit, or a policy for which this will soon be the case, consideration should be given to transferring the policy to another person to avoid the detrimental effect on the corporation's CDA.

The transfer should be structured so as to produce the most favourable tax consequence for the recipient (e.g., to avoid the transfer giving rise to a shareholder benefit). The corporation would generally realize little or no income as a result of the transfer. If the transfer is to a related corporation, the transferor corporation could remain as the beneficiary of the policy. Whether this would result in the full amount of the death benefit being credited to the transferor corporation's CDA is an issue that would require careful consideration.[9]

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Contracts Used as Security

Care should be taken where a contract is used as security for a loan. Issues that should be considered here include: (a) whether or not there has been a "disposition" for tax purposes, and (b) the impact on the CDA. (A discussion of whether or not any portion of the life insurance premiums is deductible in such situations is beyond the scope of this document, but clearly warrants consideration.) On the "disposition" issue, the taxpayer would want to be certain that the assignment is not considered to be a disposition of the insurance contract within the meaning of the Act, as income taxes could well arise on such a disposition.[10] Generally, a collateral assignment, as opposed to an absolute assignment, is not considered a disposition. (In the province of Quebec, where the policy is the subject of a hypothecary claim by a creditor, a disposition is not considered to have occurred.)

CRA's position on collateralization and how this impacts amounts that may be credited to the CDA has changed over time. The most recent significant modification to its position occurred on Feb. 10, 1997. As is provided for in the Interpretation Bulletin IT-430R3, if an insurance contract, where a private corporation is the named beneficiary, has been assigned to a lending institution as collateral for a bank loan and a death occurs, the full amount of the insurance proceeds should be credited to the named corporation's CDA, provided the corporation remained the beneficiary under the contract. The corporation is considered to have constructively received the life insurance proceeds even though such proceeds are actually paid directly to the lending institution to settle the loan.[11] On Dec. 2, 2002, CRA clarified its position on hypothecary claims in Quebec. It confirmed that with such hypothecary claims the corporate debtor would be entitled to the credit to the CDA account.[12]

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Maximizing CDA Where Parentco is Beneficiary and Subco is Owner and Pays Premiums

Another situation that warrants review is where one corporation (say Parentco) is the beneficiary of a life insurance contract on the life of the controlling shareholder, and another corporation (say Subco), a wholly owned subsidiary is the owner of the contract and pays the premiums. At issue is whether on the death of the controlling shareholder Parentco could add the full amount of the insurance proceeds to its CDA, without taking into account the ACB of the contract to Subco. CRA has issued a number of technical interpretations in this area. In the most recent technical interpretation of which we are aware, CRA has confirmed a number of key points.[13]

The first item it deals with is whether there has been a shareholder appropriation by Parentco pursuant to subsection 15(1) of the Act. CRA makes the comment that "generally subsection 15(1) would not apply to include a benefit in a beneficiary's income as a consequence of the policyholder paying the premiums due under the policy or upon receipt by the beneficiary of the proceeds of the life insurance policy as a consequence of the death of the insured".

The second item it deals with is whether the General Anti-Avoidance Rule (GAAR) would be applied to reduce the amount that Parentco credits to its CDA account by the amount of Subco's ACB. Here CRA has stated that "unless there was a bona fide reason for this structure, other than to obtain a tax benefit, the GAAR could be applied to reduce the amount of the life insurance proceeds to be included in the capital dividend account of Parentco by the adjusted cost basis of the policy to Subco". It is clear that it will be incumbent upon the taxpayer to prove that structuring the insurance in this way was not an "avoidance transaction." That is, the taxpayer will have to be able to establish that "É the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit".[14]

For more information, refer to CRA's Interpretation Bulletins IT-66R6 - Capital Dividends and IT-430R3- Life Insurance Proceeds Received by a Private Corporation or a Partnership as a Consequence of Death [Consolidated].

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Electing to Pay a Capital Dividend

Where the CDA has a positive balance (by definition it cannot have a negative balance), a corporation may consider paying a tax-free capital dividend. Corporations electing to pay capital dividends must file Form T2054 Election for a Capital Dividend Under Subsection 83(2) with the CRA on or before the earlier of the day the dividend becomes payable or was paid. The corporation will also have to submit additional information with the election, including:

a) A certified directors' resolution authorizing the election (or where the directors are not legally entitled to administer the affairs of the corporation, a certified copy of the authorization of the making of the election by person(s) legally entitled to administer the affairs of the corporation), and

b) The taxpayer should retain the detailed supporting schedules for the CDA calculation (should CRA want to review these at a later time), along with evidence that the election form was filed on time.

Where a capital dividend is to be paid, the corporation must elect "in respect of the full amount of the dividend."[16] A dividend cannot be declared where a portion of the dividend is a capital dividend and a portion is a taxable dividend. Where a corporation believes that it may not be able to sustain the position that the full amount of the capital dividend elected upon is truly a capital dividend that will withstand scrutiny by CRA, it might consider filing two elections: one for the amount of the CDA that is not in doubt; and, a second for what may be contentious. (An example of this might include a situation where a taxpayer has included the non-taxable portion of a capital gain that CRA might contend is not "on account of capital" but is "on account of income.")

If the election is late-filed, CRA will generally accept it, provided the appropriate interest and penalties are paid. The penalty is calculated as 1/12th of 1% of the amount of the capital dividend for each month (or part month) that the election is late, to a maximum of $41.67 per month, or $500 per annum. If, however, CRA has made a written request for a late-filed election, and the election is not filed within 90 days, the election may no longer be made.[17]

With any late-filed election, the taxpayer will have to satisfy CRA's guidelines. Information Circular 92-1 Guidelines for Accepting Late, Amended or Revoked Elections< issued March 18, 1992, should be referred to here.[18]

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Capital Dividends in Excess of the CDA Balance

It is essential that the amount per the dividend election not exceed the balance of the CDA at the time that the election is made. Should there be an excess, a penalty tax (referred to as Part III Tax) may be payable.[19] Part III Tax is extremely punitive and under current legislation is calculated as 75% of the excess dividend payable at the time of the election. Fortunately, the "excess" on which the corporation has paid the 75% Part III Tax is not included in the taxable income of the recipient.[20] As indicated in the most recent version of the draft technical amendments to the Act that were tabled in July 2005, Finance has proposed that this tax be reduced to 60%, effective for dividends paid after the 1999 taxation year of the corporation.[21] It is not possible to predict when the technical amendments will actually be passed, given the political situation in Ottawa.

By way of example, let's assume that a taxpayer believed that the balance of the CDA was $1,000,000 and declared a capital dividend equal to this amount. It later became evident that the true balance of the CDA was $800,000. Here, the taxpayer would be subject to the Part III Tax on $200,000. Thus, $120,000 would be payable (assuming the reduced rate of 60% is legislated), along with interest computed from the date of the capital dividend election.

Where CRA mails out the Notice of Assessment for the Part III Tax, the corporation has a 90-day period in which to make a further election.[22] Regulations specify the manner in which this second election must be made.[23] As provided for by the draft technical amendments released in 2005 (again, effective for dividends paid after the 1999 taxation year of the corporation), the election allows the dividend first elected upon (that is, on Form T2054 originally filed) to be divided into three parts: a tax-free capital dividend, a taxable dividend and the "excess" dividend that will be subject to the Part III Tax. Every effort should be made to make the election to avoid the Part III Tax. It is preferable to have the shareholder treat the excess dividend as a taxable dividend and pay the appropriate taxes thereon (approximately 30% for an individual shareholder), rather than have the corporation pay the 75% (or 60%, assuming the reduced rate is legislated) Part III Tax thereon. Where Part III Tax cannot be avoided, a second Form T2054 would be submitted, with the "excess amount" (i.e., amount subject to Part III Tax) duly entered the appropriate areas of the form.

However, this second election may only be made if certain requirements are met. First, this second election must be made with the concurrence of all the shareholders who were entitled to receive a portion of the capital dividend and whose addresses are known to the corporation. Second, the election must be made either: (a) on or before the date that is 30 months after the date on which the original dividend became payable, or (b) each shareholder who was entitled to receive a portion of the capital dividend concurred with the election and will pay the appropriate personal tax, interest and penalties on the amount (including for otherwise statute-barred years). (Special rules apply for shareholders who are exempt from Part I tax.[24])

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CDA Elections for Statute-barred Years and Impact on Dividend Refund

While in certain circumstances late-filed elections can be made to convert excess dividends into taxable dividends, getting into these situations is best avoided. In addition to the tax consequences outlined above, the possible adverse impact on the dividend refund needs to also be understood.

As outlined above, a subsection 184(3) election in respect of an excess capital dividend allows the excess dividend to be deemed to be a taxable dividend. As confirmed by CRA in a recent technical interpretation, in such a situation, the recipient (individual or corporation) will be liable for the appropriate taxes (i.e., personal taxes or Part IV taxes), even if the year for which the dividend is received is statute barred. However, the payor corporation cannot receive the dividend refund to which it would otherwise have been entitled, if the taxation year of the payor corporation is statute barred.[25]

In their recent joint submission, the Canadian Bar Association (CBA) and the Canadian Institute of Chartered Accountants (CICA) requested that the Department of Finance consider amending subsection 184(4) of the Act. The submission highlighted the concern that a corporation may not necessarily have funds to pay an additional dividend in the situation described above; hence the refundable dividend tax on hand (RDTOH) becomes "trapped." Here, the reality would be that the RDTOH becomes a permanent tax. The CBA and CICA urged the government to amend the legislation to permit a reassessment of the payor corporation when the taxation year of the payor corporation is otherwise statute barred, so that a dividend refund could in fact be obtained.[26]

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Capital Dividends Paid to Non-Residents of Canada

The provisions of the Act that deal with non-resident withholding taxes applicable to dividends paid to non-residents of Canada specifically provide that capital dividends are subject to a 25% rate of withholding.[27] Income tax treaties that Canada has entered into with various foreign jurisdictions should be referred to for a possible reduction of this 25% rate. For example, the Canada-US Tax Convention reduces the rate to 15%, with a further reduction to 5% where the shareholder is a corporation holding at least 10% of the shares of the company paying the dividend.[28]

A private corporation should investigate "streaming" distributions from the CDA in order to maximize the tax position of the various shareholders. Of course, this will have to be done in a manner that does not provoke CRA. Additionally, the anti-avoidance legislation dealing with capital dividends will have to be taken into consideration.[29]

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Summary

Private corporations have a significant tax tool the CDA at their disposal. Life insurance is acquired in a myriad of circumstances: estate and succession planning, creditor protection, key man protection, etc. Taxpayers and their advisors are urged to explore how the use of the CDA mechanism can be used to their best advantage with tips being taken advantage of and traps being avoided.

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Footnotes

1  Unless otherwise stated, statutory references in this paper are to the Income Tax Act, RSC 1985, c.1 (5th Supp.), as amended (herein referred to as "the Act".)

2  On July 18, 2005, the Department of Finance released Draft Technical Amendments and Explanatory Notes to Amend the Income Tax Act. Clause 53 proposes changes to subsection 14(1.01) of the Act, whereby a taxpayer will be permitted to simultaneously elect to report a capital gain on the disposition of eligible capital and to add an amount to the CDA. This pending amendment will generally apply to dispositions of certain eligible capital property that occur on or after Dec. 20, 2002. Also, see CRA document #2005-0147671I7, dated Sept. 20, 2005.

3  See Summary section of Interpretation Bulletin IT-430R3 Ð Life Insurance Proceeds Received by a Private Corporation or a Partnership as a Consequence of Death [Consolidated], issued Dec. 2, 2002.

4  For death benefits received before May 23, 1985, the rules relating to the "corporation´s life insurance capital dividend account" contained in part (e) of the definition of the "Capital Dividend Account" contained in subsection 89(1) should be referred to.

5  Note that special rules apply to Automatic Premium Loans (APL). Per part "B" of the definition of "adjusted cost basis" (ACB) contained in subsection 148(9), amounts described in part "B" of the definition of "proceeds of disposition" contained in subsection 148(9) do not enter into the calculation of the ACB.

6  See CRA document #2005-0132331C6, dated Oct. 7, 2005, and reported in INFOexchange 2006 Vol 1.

7  1969-75 mortality tables of the Canadian Institute of Actuaries, published in Volume XVI of the Proceedings of the Canadian Institute of Actuaries. Required for calculating the NCPI by Regulation 308 of the Income Tax Regulations.

8  See CRA document #2005-0114801E5, dated May 12, 2005.

9  See the CRA´s response to question 5 at the 2004 CALU Annual Meeting (CALU Report, June 2004), as well as CRA document #9824645, dated Dec. 15, 1998.

10  See part (f) of the definition of "disposition" contained in subsection 148(9).

11  See paragraph 6 of Interpretation Bulletin IT-430R3 Ð Life Insurance Proceeds Received by a Private Corporation or a Partnership as a Consequence of Death [Consolidated]. For more information on this change, refer to CRA document #9707185, dated April 8, 1997.

12  See "Bulletin Revisions" section at end of Interpretation Bulletin IT-430R3 Ð Life Insurance Proceeds Received by a Private Corporation or a Partnership as a Consequence of Death [Consolidated].

13  See CRA document #2004-0065461C6, dated May 4, 2004.

14  See section 245 of the Act and Information Circular 88-2 and Supplement: General Anti-Avoidance rule.

15  Regulation 2101 should be referred to for requirements relating to the filing of the election to pay a capital dividend.

16  See subsection 83(2).

17  See paragraph 5 of Interpretation Bulletin IT-66R6 Ð Capital Dividends, dated May 31, 1991.

18  Please note that Regulation 600 was amended to include subsection 83(2) elections to its "List of affected elections" (per IC 92-1) to which these guidelines apply, effective Dec. 15, 1993.

19  See subsection 184(2).

20  See paragraph 17 of Interpretation Bulletin IT-66R6 Ð Capital Dividends, dated May 31, 1991.

21  See Clause 163 of the Draft Technical Amendments and Explanatory Notes to Amend the Income Tax Act, dated July 18, 2005, which amends subsections 184(2) to (5) of the Act.

22  See subparagraph 184(3).

23  Regulation 2106 should be referred to here.

24  See section 103 of the Draft Technical Amendments and Explanatory Notes to Amend the Income Tax Act, dated Feb. 27, 2004, for changes to subsection 184(5).

25  See CRA Document #2003-0051211I7, dated Jan. 30, 2004.

26  See submission of July 29, 2005, to the Department of Finance by The Joint Committee on Taxation of The Canadian Bar Association and The Canadian Institute of Chartered Accountants to the Department of Finance. (Available on the Web athttp://www.calu.com/publications_.html)

27  See paragraph 212(2)(b).

28  See Article X(2) of the Canada-US Tax Convention.

29  See subsection 83(2.1).

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About the Authors

Sandra Bussey, CA,is in KPMG's Waterloo, Ontario, office and may be contacted via e-mail at sbussey@kpmg.ca or by phone at (519) 747-8820.

Lea Koiv, CA, CMA, CFP, is at the North York, Ontario, office of The Standard Life Assurance Company of Canada, and may be contacted by e-mail at lea.koiv@standardlife.ca or by phone at (416) 224-3253.

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