I have a corporate client who has a large investment. On this investment, the company received a T5 from the investment company. There were regular dividends, but also there was a capital gains dividend in box 18. Where/how do I record this on S3 on the T2.
Help!
Kevin@padgettsherwood.ca
Not on S3. Report on S6, line 875.
Thank you.
I’ve been trying to do a bit of research on “capital gains dividends”, to understand exactly what they are. I know they go on T2 S6, but want to know why, and whether they relate to “capital dividends”.
It took some digging, but I found something at CRA that seems to indicate they relate to ITA 131(1). Looking that up, it sounds like capital gains dividends are a special type of dividend that can be paid only by a mutual fund corporation, and they “come out of” a special “capital gains dividend account” that exists only for mutual fund corporations. From what I can gather, this “capital gains dividend account” balance is essentially made up of capital gains, which is why the recipient reports it on S6. Does that sound correct?
So, they have nothing to do with “capital dividends” which come under ITA 83. Right?
You’re right, capital gains dividends are paid out by mutual fund investments and ger reported on a T3, and are reported by the recipient corp on S6. If you think of it, a trust’s income retains its characteristics when it is paid out to the beneficiaries. Which is why a T3 slip often has the total distributions broken down among half a dozen categories.
A capital dividend is an amount paid out by a corp from its capital dividend account. This account accumulates the non-taxable, or non-deductible capital gains & losses over the years. A positive balance means the corp’s gains have exceeded its losses, and this is paid out to the shareholders tax-free. No T-slip is issued, but you need to confirm the CDA balance, submit a directors resolution, and S89. In about a year, CRA will confirm that the payment meets their criteria and it shows up on the corp’s CRA file. Originally, the corp paid the high rate tax on 50% of its capital gains. It gets to keep the untaxed 50%, which can then be paid to the shareholders tax-free. When you receive a T3 slip with a capital gains dividend, that is 100% of the capital gain received from the mutual fund. It is ten taxed to the recipient and S6 is the place to report it. At the bottom of S6, the 50% taxable amount is calculated and transferred to S1. The CDA is a good thing to keep an eye on for your clients as it represents tax-free money which can be extracted. Depending on the time involved, I charge in the area of $700 - $1,500 to get all the forms ready, signed, and submitted. You can get a good fee for these since the client is getting something substantial tax-free. They can see the benefit in your fee.
Actually, they show up on T5 slips as well. But, I don’t see them that often. This one I’m working on, I used the fiscal year statement from the client’s investment broker, and what was listed as “dividends” I entered on the T2 S3. Later, I saw the same amount on the client’s T5 box 18. Since this is a corp with a March year-end, the T slips are mostly irrelevant. But, when I noticed it was a “capital gains dividend”, I moved the value on S3 to column E “Non-taxable dividends under section 83” (thinking “capital gains dividend” = “capital dividend”). Two days later, when reviewing the T2, I entered the amount on S6 Part 8 (line 875), forgetting that I had already put it on S3. Today, I reviewed the T2 Summary (one more time, before sending it to the client), and the CDA balance seemed unusually high. I investigated and I realized I had the same value in both places. I started to wonder which was correct, and why. That’s when I started researching what “capital gains dividends” really are, and where they come from.
I think I will have to review T2s I’ve prepared over the last few years, in case I made this mistake before. No need to look more than 4 year back, though, right? Statute barred?
A March year end does screw up any hope you had of matching T-slips with the investment statements. Although, for December year ends, there is very often income reported on a T-slip that isn’t deposited to the margin account until January. Then you’ve got receivables to track. And, you can’t believe the language on the monthly statements. What they call “dividends” can, and does, run the gamut from return of capital (a cost reduction), to interest, foreign dividends, eligible Canadian dividends, other income, and on and on. So, when I’m recording the slips via journal entry, I always check the schedule attached to each T-slip and look for distributions dated in January. I’ve just finished a client where I’ve done this. Debit margin account for amount received in the year, debit receivables if there’s any, debit tax expense for foreign tax, credit investment cost for return of capital, then credit the various income categories. Record any cash invested or withdrawn in the year. Debit margin acct for proceeds of sale, credit investment acct for cost, credit capital gain for the remainder. Credit margin account for investments purchased. Account for movement between Canadian and US margin accounts. This year, both accounts agreed with the December statement (doesn’t always work out immediately). If I’ve recorded everything correctly, the investment account balance agrees with the total cost base on the December statement. There will be differences, which I track every year as some brokers (CIBC, for example), do not reduce the book value for any return of capital. I don’t know what they think happens to it in the accounting process. It’s certainly not income. I have another GL account which I use to adjust cost to market. Portfolio investments traded in a recognized market are to be reported at market value, since it’s readily available. One of the last pages of my financial statements lists every security, opening quantities, additions & disposals, opening cost plus & minus changes, closing cost, and market value. I highlight those securities with an unrealized loss for the owner. It’s a tedious job. But satisfying to see it all come together. I have a client who was with another CA firm years ago, and they always had his work done by the end of February, and for a low price. The fee increased dramatically in my first year. The previous accountant took entries from the trading summary to record purchases/sales, and all income was treated as eligible dividends. They had built up a huge RDTOH, and huge non-capital losses. I didn’t touch their work, but I did it correctly from my initial year with the client. From that experience, I can only conclude that CRA never matches T-slips to a T2. I have had a client that amalgamated during the year, resulting in a short year end. So, I did one period from Jan.1 - July 17, and a second statement for July 18 - Dec.31. In that case, I guessed at the income allocation as a best guess, using the prior year distribution as a guide. Fortunately, most of the securities remained the same. Then, for the December statement, I made the necessary corrections so that the 2 periods together matched the T-slips for the year. I got double the fee that year.
I concur. I have been doing it the same way @jhd.hemeon does it.
The definition “dividends” used on broker statement is not the same as the way it is used in the ITA [referring to eligible or non-eligible dividends].
So the broker definition is more like “distribution” and capital gains dividends is a distribution that is classified as a capital gain and should be recorded on Schedule 6.
I usually record the distributions of trusts/mutual fund as interest income and then do the re-allocation when I get the T3.
Re: investment analysis - I generally follow what I was taught at MNP years ago:
A basic corporate year-end engagement does NOT include detailed investment analysis. Most of us don’t have specialized expertise in that area, but the investment broker does (or at least has the information at their fingertips) - THEY should do the analysis and provide the proper breakdown for tax purposes. Most clients don’t want to pay us an extra $5,000 to go through all their investment transactions and figure out the tax effects that they are already paying their investment broker to do.
That said, there are a few clients who don’t have a complex investment portfolio, or are willing to pay us to do investment analysis because they don’t use a broker, etc. In those cases, yes, I’ll look at the T slips. Otherwise, I tell my clients to either:
BUT, my original question was NOT about overall investment analysis! It was only about the concept of CAPITAL GAINS DIVIDENDS - what those actually are; where they come from; why they have a name that is so easily confused with CAPITAL DIVIDENDS!
I don’t think I’d call what I do as a detailed analysis. I do what is necessary so as not to submit an incorrect T2. I record all income from all T-slips, all buys/sells from annual trading summary, check the foreign property report to see if one has to be filed, and then look at my trial balance. If the cash account doesn’t agree with the year end statement, I find the answers. Same thing if investment cost per my trial balance doesn’t agree with the investment statement. You can’t just plug the difference somewhere and claim you’ve done a proper job. Then I’ve got to deal with the code of conduct requirement that I “not be associated with information which I know, or should have known, to be false or misleading”. “Information” includes financial statements.
Brokers can NEVER be trusted to have the right cost amounts where there has been a return of capital included with the “distributions”. I know of an individual with an investment holding company who also has personally held investments. His cost was $500,000, market value over $700,000. Personal investments transferred to corp using section 85, broker lists cost to corp at $700,000. To use their numbers as sales are made eventually results in an understated capital gain of $200,000. Brokers are sometimes good at their job, they keep their client’s interests at heart, and they are easy to get missing information from. But, for the most part, they aren’t accountants or tax preparers. I still remember the firm that reported all distributions as eligible dividends, with no regard for the facts. If CRA ever looked, they’d have a field day. Client would look to the accountant for compensation, and he never gets insurance again. Plus, his provincial association can (and have, in the past) revoked his designation, his license, fined him, and ended his career.
I do agree that CRA’s terms should be improved. Capital gains dividend is pretty straightforward, if contradictory. It’s a distribution which arose in the issuer’s business as a capital gain, and, as such, is reported by the recipient as a capital gain. A dividend and a capital gain are 2 different animals. Why not just call it a capital gain.
Capital dividends should more properly be described as a tax-free distribution from the payor’s capital dividend account. There is no T-slip to report these.
Language terms, and how we understand them, often make no sense. I remember a George Carlin monologue where he talks about a near miss and a near hit.
“Boy, did we ever luck out there, had a near miss with another plane.”
No, what you had was a collision, and you’re dead. A near miss means you hit the damn thing. What you should have said was - we had a near hit.