Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Capital Dividend Account (CDA)

What it is:

A capital dividend account is a special account that companies use to pay tax-free dividends to shareholders.

How it works (Example):

Let's say five people pool their capital to form a company. They each contribute $10,000 for a total of $50,000.

As the company grows and earns profits, those profits increase the company's retained earnings.

Eventually, the company decides to pay dividends to its shareholders. Where those dividends come from is very important to the shareholders; if they come from retained earnings, they are taxable as dividend income. If they come from the CDA, however, they are not taxable, because that's the account holding the five owners' original investments. Because the dividend is actually a return of capital when it comes from the CDA, it is tax-free (because the five shareholders paid taxes on that money already).

Why it Matters:

Common in Canada, CDAs help companies and shareholders separate seed capital from profits. In turn, they help shareholders know which dividends are taxable and which are not taxable.