An asset sale is taxed twice. The corporation pays first — on recapture under Income Tax Act subsection 13(1), which enters income in full, and on the taxable half of any capital gain under section 38. The shareholder is taxed again to get the money out. One slice escapes: the non-taxable half of the gain, which leaves through the capital dividend account.
Key takeaways
SECTION 01 OF 11
Two inclusions, on different property, on different terms. First, recapture: subsection 13(1), marginal note Recaptured depreciation, provides that where the credits in a depreciable class exceed the debits at year end, “the excess shall be included in computing the taxpayer’s income of the year”. In income — not half of it.
The second is the capital gain: paragraph 40(1)(a) measures it as proceeds less adjusted cost base and costs of disposition, and paragraph 38(a) provides that “a taxpayer’s taxable capital gain for a taxation year from the disposition of any property is ½ of the taxpayer’s capital gain”. Which inclusion a dollar of price produces is settled by the allocation; Treadstone Law sets both layers out in its note on double taxation.
SECTION 02 OF 11
Recapture is not a capital gain, so it has no non-taxable half, so none of it reaches the capital dividend account. Tax is paid on all of it, and every dollar left must then leave as a taxable dividend.
Recapture is at least capped. Element F of the subsection 13(21) definition of undepreciated capital cost takes, per disposition, “the lesser of (a) the proceeds of disposition of the property… and (b) the capital cost to the taxpayer of the property”. Proceeds above original cost become a capital gain instead, and half of that does reach the account. Treadstone Law explains why recapture is taxed differently.
SECTION 03 OF 11
The first component of the subsection 89(1) definition is a subtraction: it takes “the amount of the corporation’s capital gain” and subtracts “the portion of the capital gain referred to in clause (A) that is the corporation’s taxable capital gain”. Gain minus taxable gain is the non-taxable half, and that is what the account holds.
Old losses cut the other way, and one taken years ago is still there on closing day: where non-deductible losses exceed non-taxable gains, the CRA’s Income Tax Folio S3-F2-C1 says “no amount in respect of the first component will be recognized as an addition to the corporation’s CDA until the running balance… is once again a positive amount”. Owner-built goodwill does count: the folio confirms Class 14.1 gains reach Component 1 (goodwill).
SECTION 04 OF 11
The folio is blunt: “Because the CDA is a running balance account, capital dividends paid by the corporation will reduce the account balance.” The definition itself ends the same way, subtracting “all capital dividends that became payable by the corporation” earlier in the period.
Balances flow upward. Paragraph (b) adds “an amount in respect of a dividend received by the corporation on a share of the capital stock of another corporation… not included in computing the income of the corporation” — so a holding company inherits the room. A vendor take-back defers it: subparagraph 40(1)(a)(iii) allows “a reasonable amount as a reserve” for proceeds “payable to the taxpayer after the end of the year”.
SECTION 05 OF 11
Nothing happens automatically. Subsection 83(2) operates only where a dividend becomes payable by a private corporation and “the corporation so elects in respect of the full amount of the dividend, in prescribed manner and prescribed form”. Where it applies, “no part of the dividend shall be included in computing the income of any shareholder of the corporation”.
The prescribed form is Form T2054, “For use by a private corporation to elect to have the provisions of subsection 83(2) apply to a dividend.” The folio puts the deadline at the earlier of “the day on which the dividend becomes payable” and the first day any part is paid — often long before the corporate return is drafted. Late filing costs “the lesser of $41.67 or 1/12 of 1% of the amount of the dividend” per month.
And tax-free means tax-free to Canadian residents: the folio records that “Capital dividends paid to non-residents are subject to non-resident withholding tax of 25% under subsection 212(2)”. See Treadstone Law on capital dividends.
SECTION 06 OF 11
Elect more than the account holds and the shortfall is not simply taxable to the shareholder. Subsection 184(2) requires the corporation to “pay a tax under this Part equal to 3/5 of the excess”; the folio states the same charge as “60% of the excess amount plus interest until the date of payment”, and makes recipients liable for their share.
The escape needs consent. Subsection 184(3) applies where the corporation elects “on or before the day that is 90 days after the day of sending of the notice of assessment”, and the excess “is deemed to be a separate taxable dividend”. But the folio notes it “can generally be made only if there is agreement from all the shareholders” entitled to part of the original dividend — so one dissenting minority holder leaves the charge where it fell. Treadstone Law’s case study follows that pattern.
SECTION 07 OF 11
After the corporate tax is paid the cash is still the corporation’s, and taking it out is a separate taxable event. Subsection 84(2), marginal note Distribution on winding-up, etc., deems a dividend equal to the excess of “the amount or value of the funds or property distributed or appropriated” over the amount by which “the paid-up capital in respect of the shares of that class is reduced”.
The deemed dividend is not also a capital gain on the shares. Section 54 excludes from “proceeds of disposition” “any amount that would otherwise be proceeds of disposition of a share… deemed by subsection 84(2) or (3) to be a dividend received”. The extraction is taxed once, as a dividend, and often leaves a capital loss where share cost exceeded paid-up capital — where Treadstone Law’s article on winding up starts.
SECTION 08 OF 11
Subsection 88(2), marginal note Winding-up of Canadian corporation, applies where all or substantially all of the property is distributed. It first fixes the timing so the account can be computed: a taxation year is deemed to end, and each distributed property is “deemed to have been disposed of… for proceeds equal to the fair market value of the property immediately before the particular time”.
Then it cuts the deemed dividend. Under paragraph (b), “such portion of the winding-up dividend as does not exceed the corporation’s capital dividend account immediately before that time” becomes the full amount of a separate dividend for an 83(2) election — which matters, because 83(2) demands an election on a dividend in full. The rest “shall be deemed to be a separate dividend that is a taxable dividend”.
SECTION 09 OF 11
The corporate tax on a capital gain is partly refundable, and the second dividend is what refunds it. Section 123.3 adds “an amount equal to 10 2/3% of the lesser of” a CCPC’s aggregate investment income and its taxable income above the small-business limit; taxable capital gains are in that base under subsection 129(4), and recapture, being business income, is not. Subsection 129(1) then directs a refund “in respect of taxable dividends paid by the corporation on shares of its capital stock in the year”. Treadstone Law explains the pool in refundable dividend tax on hand.
SECTION 10 OF 11
None of these figures is data; they are parameters I picked to show the mechanics. A corporation sells Class 8 equipment with a capital cost of $500,000 and an undepreciated capital cost of $180,000 for $400,000, and land with an adjusted cost base of $300,000 for $1,100,000. Element F takes the lesser of proceeds and capital cost, so $400,000 comes off the class and leaves it $220,000 negative: recapture, into income in full, with no capital gain because proceeds fell below original cost.
The land produces an $800,000 capital gain. Paragraph 38(a) makes $400,000 of it taxable; the other $400,000 is what subsection 89(1) adds to the account. The inclusion for the year is $620,000, and only $400,000 of the $1.5 million of proceeds can ever leave tax-free.
Say paid-up capital is $100 and the corporation winds up with $1,150,000 after its tax. Subsection 84(2) deems a dividend of $1,149,900; under subsection 88(2) the first $400,000 is a separate dividend eligible for the 83(2) election and $749,900 is taxable. That last figure is the price of the structure.
SECTION 11 OF 11
It settles the shape of the comparison, not the rate. A share sale puts the gain in the shareholder’s hands directly and can reach the lifetime capital gains exemption where the shares qualify (the 24-month rule, why vendors prefer shares, pricing the difference). No rate appears here: rates differ by province and by dividend type, and the mechanism generalises where a rate does not. A rollover is no answer on a cash sale — Treadstone Law’s answer on section 85 explains it needs share consideration. The deal also carries a section 22 election, a GST/HST election and often a pre-closing dividend.
No. Recapture is included in income in full, with no non-taxable half, so none of it reaches the capital dividend account — only a capital gain, which is half taxable, adds its non-taxable half to that account. Every dollar of recapture left in the corporation must eventually leave as a fully taxable dividend.
The corporation is charged a tax equal to three-fifths of the excess, unless it elects within 90 days of the assessment to have the excess deemed a separate taxable dividend instead — and that escape generally requires agreement from every shareholder entitled to part of the original dividend.
No. Getting the remaining cash to the shareholder is a separate taxable event, taxed as a deemed dividend to the extent it exceeds the paid-up capital of the shares — only the portion covered by a capital dividend election can pass through tax-free.
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