Your capital dividends may be at risk When can a corporation safely pay a capital dividend without fear of a challenge from the Canada Revenue Agency (CRA) — one year, three years, four years after the sale of a capital asset? Many business owners are misinformed, and the answer is more complicated than you'd think. It sounds straightforward: when a corporation sells a capital asset, only half of the capital gain is taxable. The non-taxable portion is added to the company's capital dividend account (CDA), a notional account that the company can use to pay tax-free dividends to shareholders. The CRA has three years, in the case of a Canadian-controlled private corporation (CCPC), or four years, in the case of a non-CCPC, to challenge and reassess the capital gain treatment. After this time, except in very limited circumstances, the CRA can no longer reassess and the years are considered "statute-barred." A general misconception among business owners is that, once the year that gave rise to the capital gain becomes statute-barred, it's safe to pay the capital dividend. In fact, without careful planning, a company could find that it's subject to an infinite statute of limitations period on capital dividends. This situation can become an issue for those corporations that aggressively treat income as a capital gain, or those that want to prematurely clear out their CDA. The CRA bases the CDA on actual capital gains and losses, not on a company's income tax assessment. Although the CRA can't reverse the capital gain treatment once a year becomes statute-barred, it can, if it decides that the capital gain should have been regular income, reassess the corporation's CDA. Conversely, if, for some reason, a corporation fails to report a capital gain and the year becomes statute-barred, the company could still include the non-taxable portion of the gain in its CDA. For the statute of limitations on capital dividends to kick in, an assessment must be triggered. Filing a capital dividend election doesn't in itself result in an assessment; the CRA must actually issue an excessive assessment for the statute of limitations to take effect. When the CRA believes a company has made a CDA election for an amount that exceeds the balance in its CDA account, the CRA will issue an assessment, with the resulting tax equal to 75 per cent of the excessive capital dividend. However, the corporation and its shareholders can avoid this punitive tax by electing to treat the excessive capital dividend as a separate taxable dividend. To avoid an infinite statute of limitations period on capital dividends paid where a potentially risky capital gain position has been claimed, the corporation may want to trigger an assessment by filing an excessive capital dividend. For example, if the corporation's CDA is $1,000, it should pay out a capital dividend of $1,005. Once the assessment is issued, the CRA has a maximum of three to four years to reassess. When this period has passed, the corporation can distribute its CDA balance for the years up to the assessment without fear of challenge from the CRA. Silvia is a Canadian Tax Manager. She can be reached at (416) 644-4424 or by e-mail at silvia_jacinto@mintzca.com. Mintz & Partners | 1 Concorde Gate, Suite 200, North York, Ont., M3C 4G4 | www.mintzca.com Phone: (416) 391-2900 | Fax: (416) 391-2748 | E-mail: info@mintzca.com Tax Alert is an e-newsletter written by the Tax Team of Mintz & Partners LLP. Please go to http://www.mintzca.com/index.php?section=taxdirectory to learn more about our Tax Team. The issues raised are for information purposes only. Readers are urged to contact their professional advisors before acting on the basis of the material contained herein. |