ARTICLE
13 September 2024

Finance Releases Revised Rules For Capital Dividend Account (CDA) Computations

MT
Miller Thomson LLP

Contributor

Miller Thomson LLP (“Miller Thomson”) is a national business law firm with approximately 525 lawyers working from 10 offices across Canada. The firm offers a complete range of business law and advocacy services. Miller Thomson works regularly with in-house legal departments and external counsel worldwide to facilitate cross-border and multinational transactions and business needs. Miller Thomson offices are located in Vancouver, Calgary, Edmonton, Regina, Saskatoon, London, Waterloo Region, Toronto, Vaughan and Montréal.
Budget 2024 announced an increase to the capital gains inclusion rate from one-half to two-thirds for all corporations and trusts...
Canada Tax

Budget 2024 announced an increase to the capital gains inclusion rate from one-half to two-thirds for all corporations and trusts, and an increase to two-thirds on capital gains realized by individuals on or after June 25, 2024 in excess of an annual $250,000 threshold.

On June 11, 2024, Parliament passed a Notice of Ways and Means Motions (“NWMM”) which included amendments to the Income Tax Act  (Canada) (the “Tax Act”) to implement the proposed increase to the capital gains inclusion rate and consequential amendments. On August 12, 2024, the Department of Finance released legislative proposals relating to various tax matters, including amendments to the capital gains inclusion rate package contained in the NWMM (the “August 12 Proposals”).

This article briefly discusses modifications to the rules for computing the capital dividend account (“CDA”) as set out in the draft legislation contained in the August 12 Proposals.

Background

Very generally, the CDA is a notional tax account maintained by a corporation, which tracks the non-taxable portion of capital gains net of non-allowable capital losses. The CDA enables a private corporation to pay a tax-free dividend to its Canadian-resident shareholders by electing that such dividend be a “capital dividend” as described by subsection 89(1) of the Tax Act.

The proposed increase to the capital gains inclusion rate impacts the computation of the CDA insofar as the non-taxable portion of capital gains and the non-allowable portion of capital losses realized by private corporations will be decreased from a one-half (50%) to a one-third (33 1/3%) rate. The draft legislation contained in the NWMM includes specific rules for computing the capital gains inclusion rate for a transition year (i.e., a taxation year that begins before June 25, 2024 and ends after June 24, 2024). Under these rules, a transition year would be subject to a blended inclusion rate comprised of the prior 50% rate and the new 66 2/3% rate based on the timing and the value of the dispositions occurring in the transition year.

Issues with the CDA computation rules contained in the NWMM

The proposed blended rate for a transition year may lead to discrepancies when calculating a corporation's CDA because the blended rate for a transition year can only be determined after the transition year ends, whereas CDA is calculated on a point-in-time basis.

This timing incongruity may lead to uncertainty where a private corporation realized a capital gain prior to June 25, 2024 and paid capital dividends to its shareholders out of its CDA balance in an amount equal to 50% of the gain (or the non-taxable portion of the gain prior to June 25, 2024) before the end of the transition year. Under the draft legislation contained in the NWMM, if after the transition year ends, it was determined that the private corporation's blended rate actually exceeded the 50% rate, then the non-taxable portion of the capital gain would be less than 50%, which could potentially result in a excessive CDA designation (and the assessment of penalties).

New proposed CDA computation rules

The explanatory notes to the August 12 Proposals expressly recognize the existence of this issue:

[...] a corporation can only determine its inclusion rate in the transition year after the year ends. This timing consideration may be incompatible with the computation of the CDA balance, which is determined at any time in the year to establish the amount of dividends that the corporation can elect to pay as tax-free capital dividends.1

To address this issue, new proposed paragraph 89(1.4)(a) of the Tax Act deems, for the purpose of calculating CDA during a transition year, that: (i) one-half of a capital gain (or capital loss) realized by a corporation is to be added (or deducted as applicable) in computing a corporation's CDA balance in respect of a disposition of property occurring before June 25, 2024, and (ii) two-thirds of a capital gain (or capital loss) realized by a corporation is to be added (or deducted as applicable) in computing a corporation's CDA balance in respect of a disposition of property occurring after June 24, 2024.

In effect, the August 12 Proposals substitute the concept of a blended rate with the new deeming rule contained in new proposed subsection 89(1.4) of the Tax Act. This is a welcome development and should provide taxpayers with a greater degree of certainty in respect of transactions that occurred during a transition year.

Furthermore, the August 12 Proposals contain other special rules aimed at preventing a corporation from exaggerating or understating its CDA for a transition year, where the corporation's inclusion rate for the transition year differs from the deemed one-half or two-thirds rate used to compute the corporation's CDA under new proposed paragraph 89(1.4)(a). In these instances, there is a true-up at the end of the transition year by deeming a capital gain or loss when computing CDA to adjust for any differences between the inclusion rate under the transitional and the new rules.

Several other interpretive issues have been raised by the tax community with respect to the draft legislation to implement the increase to the capital gains inclusion rate announced in the 2024 Budget and we continue to consider how these changes may affect you. If you have any questions regarding the computation of CDA or any other measures contained in the August 14 Proposals, please contact a member of the Miller Thomson LLP  Corporate Tax group.

Footnote

1. Explanatory Notes to Legislative Proposals Relating to the Income Tax Act and Regulations (Capital Gains Inclusion Rate) (August 28, 2024), available online: .

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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