The capital dividend account (CDA) is a special corporate tax account that gives shareholders designated capital dividends, tax-free. When a company generates a capital gain from the sale or disposal of an asset, 50% of the gain is subject to a capital gains tax.

An operating or holding company purchases a life insurance policy on the shareholder’s life, and an annuity on a separate contract. The shareholder is the life insured and the corporation is named as the beneficiary. Generally, the annuity payments are used to pay the life insurance premium and the tax on the annuity. The amount remaining can be paid out to the shareholder as a bonus or a dividend.

On the death of the shareholder, the life insurance proceeds are paid to the company and generate a credit to its Capital Dividend Account (CDA). Under certain conditions, the insurance proceeds may be paid tax-free to the shareholder’s estate (via a tax-free capital dividend) and distributed to the heirs or charity, as directed in the will.