Canada's tax system levels the tax playing field so that taxpayers who invest using a private corporation aren't taxed differently from those who invest directly.

In other words, private corporations can distribute certain funds to shareholders as tax-free dividends. Those

payouts come from the capital dividend account, which is used to keep track of various tax-free surpluses such as:

These surpluses are distributed tax-free to Canadian-resident shareholders. If your company switches from non-private status, you accumulate a capital dividend account only after the date it became private.

Important points to consider when you are planning to pay a capital dividend include:

• The election to pay the dividend must be sent to Canada Revenue Agency by the earlier of the date the dividend is payable or a portion thereof is paid. Late elections are subject to a penalty.
• You will be hit with a tax equal to 75 per cent of the dividend amount that exceeds the account balance.
• Capital dividends can be declared and paid any time during your financial year.
• If you realize a capital loss or business investment loss after the payout and the dividends had reduced the account balance to zero, those dividends won't be affected. The balance must become positive before you can pay out another dividend.
• The dividend may be taxable if a holder's main purpose in buying shares was to get the payout.

Major tax consideration: Pay a dividend as soon as it becomes available, particularly if there is a possibility of incurring losses in the future. Keep a running account balance to avoid missing an opportunity.