(From the March 2026 edition of eFORUM) 

By Kevin Wark

Owners of private corporations know the benefits of a capital dividend account (CDA) credit. It gives the company the ability to pay dividends from its CDA completely tax-free to Canadian resident shareholders.

The CDA typically includes the non-taxable portion of capital gains (net of capital losses) and life insurance proceeds received by a corporation (net of the policy’s adjusted cost basis)[i]. It’s a cumulative amount, and reflects positive and negative transactions over a company’s lifetime.

Accuracy is essential. As demonstrated by the recent Keystone court decision, a miscalculation can trigger adverse and substantial tax consequences.

The Keystone case: A costly miscalculation[ii]

In 2023, the accountant for Keystone Enterprises Real Estate Ltd. confirmed the company had a CDA balance of $721,465 available, which could be paid out tax-free to its shareholders.[iii] Keystone paid that amount to its two individual shareholders in August 2023 and filed the required election form with the Canada Revenue Agency (CRA)[iv].

Yet in June 2024, the CRA reviewed the filing and reached a different conclusion. The agency determined Keystone’s CDA balance at the time of payment was only $184,464, resulting in an excess election of $537,001.

The CRA told Keystone it could either:

• pay a penalty tax equal to 60% of the excessive election; or
• treat the excess amount as taxable dividends paid to the shareholders.[v]

Keystone did not respond to the CRA and in October 2024, the agency issued a notice of assessment for the 60% tax on the excessive elections.

Turning to the courts

In response, Keystone applied to the Saskatchewan’s Court of King’s Bench, for a rectification order. The company asked the court to reduce the elected capital dividend to the amount actually available in its CDA at the time of payment.

The Attorney General of Canada, acting for the CRA, opposed the application.

During the court proceedings, Keystone’s accountant acknowledged an error in calculating Keystone’s CDA. He had failed to account for a capital dividend previously paid to a former shareholder. Keystone argued it had always intended to declare only tax-free capital dividends, and the two shareholders indicated they would repay the excess amount.

The Attorney General countered that Keystone had determined the CDA balance was $721,465 and reflected that figure in its corporate resolution. Granting rectification would require the court to “rewrite the history of the declaration and resulting payment of the dividend following the realization of an unintended tax liability.”  In other words, the court could not rewrite a company’s past decisions simply because they had discovered a tax mistake after the fact.

Intent is not enough

The court then looked at earlier Supreme Court of Canada decisions on granting rectification orders.[vi] Those cases provided clear guidance on the limits placed on courts when “fixing” legal documents. Courts can grant rectification when a written document does not accurately record an agreement between parties. Courts cannot use rectification to undo a transaction simply because it led to an unexpected tax bill.

Based on these earlier decisions, the court concluded it could not modify an agreement or instrument merely because it resulted in an adverse and unplanned tax liability. It further noted a broader tax principle: taxpayers face the tax consequences of what they did, not what they could have done.

Because the court found no error in how Keystone recorded the directors’ resolution to pay the dividend to shareholders, the resolution accurately reflected what the directors approved at the time. The document matched the parties’ decision, so the court refused to grant rectification.

Lessons for tax advisors

The Keystone decision reinforces a critical point. Owners of private corporations – and their tax advisors – must properly calculate their CDA balance before paying a capital dividend.

As the Keystone decision illustrates, an error can lead to:

• a punitive excess election tax for the corporation; or
• the payment of taxable dividends to shareholders.

Additional complications arise when a corporation receives life insurance proceeds, which can create a CDA credit. CRA interpretations and anti-avoidance tax rules can result in the credit being lower than expected.

As the Keystone decision illustrates, corporations should carefully review the calculation of their CDA balance before declaring a capital dividend. A miscalculation can quickly turn a tax-free distribution into a costly tax mistake.

A version of this article was previously published by the Conference of Advanced Life (CALU) and is being published with its permission.

Kevin Wark, LLB, CLU, TEP, is managing partner of Integrated Estate Solutions and a tax advisor to CALU. He is the author of the popular consumer book The Essential Canadian Guide to Estate Planning (3^rd ed.), as well as tax guides on corporate-owned life insurance, life insurance transfers, insured buy-sell agreements, and income-splitting strategies, available through Amazon.ca.