Feds’ draft legislation eases some concerns around capital dividend accounts, estate planning

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Draft legislation released this week offers relief to business owners worried about managing their capital dividend accounts (CDAs) this year after changes to the capital gains inclusion rate, and also addresses issues around loss carrybacks in estate planning.
The Department of Finance released draft legislation on Monday that clears up a potential problem for private corporations calculating gains for their CDAs.
The non-taxable portion of capital gains for a Canadian-controlled private corporation is added to the company’s CDA balance, which can generally be paid tax-free to shareholders.
With changes announced in the federal budget, the capital gains inclusion rate for corporations increased from 50 per cent to 67 per cent on June 25.
For CDA additions this year, many expected the rate would be 50 per cent for capital gains before June 25 and 33 per cent for gains realized after. However, that’s not how it worked in the notice of ways and means the Liberal government tabled on June 10.
Those rules introduced a complex “blended” formula to calculate the inclusion rate if a corporation realized gains this year both before and after June 25.
This created problems for business owners who wanted to pay out their capital dividend on a pre-June 25 sale, which was taxable at 50 per cent, before they generated more gains from a second disposition after June 25 at the higher rate.
“If you’d done that before the second capital gain was realized, you wouldn’t have a sufficient CDA balance to support the capital dividend being claimed,” says Brian Ernewein, senior advisor at KPMG in Canada’s national tax centre.
A number of tax experts identified the problem and the potential penalties that could result from distributing capital dividends above the amount available in a CDA.
“What the department has done in the legislation is essentially turn off that blending rule so that you can indeed pay out the 50 per cent exempt gain before any further gains are realized,” Mr. Ernewein says.
For capital gains realized before June 25 this year, 50 per cent of the gain is added to the corporation’s CDA; for gains realized after June 25, 33 per cent is added.
The other change Mr. Ernewein noted relates to the loss carryback provision in estate planning – when an estate carries back a capital loss to offset a capital gain realized by the deceased.
When a private company owner dies, their shares in the company are deemed disposed at fair value. But when the company is wound up, estate beneficiaries are taxed on the dividend distribution.
One way to avoid this double tax is to have the company buy back the shares, triggering a deemed dividend that results in a capital loss to the estate. That loss can be offset against the deceased’s capital gain, Mr. Ernewein says.
But executors have to do this within one year of the shareholder’s death. The draft legislation would extend that to three years, allowing more time for planning.
Sometimes the estate has to go to probate or there are disputes among beneficiaries, Mr. Ernewein says. “The flexibility that this additional 24 months gives can be important in a lot of circumstances.”
The short timeline has always been an issue, he says, but the higher capital gains inclusion rate makes it more significant, “and giving two extra years for planning will help mitigate that.”
The legislative proposals are out for consultation until Sept. 3, with legislation to enact the measures expected to be tabled in Parliament this fall.
Those proposals also include tweaks to the new Canadian Entrepreneur Incentive – adjustments that business groups says don’t go far enough, the Globe’s Mark Rendell reports.
And the Liberals proposed changes to bare trust reporting rules. As Rob Carrick writes, fewer individuals will need to report to the CRA, hopefully avoiding the confusion we saw at filing time this year.
– Mark Burgess, Globe Advisor assistant editor
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