Canco was the owner and beneficiary of a life insurance policy, with an adjusted cost basis of nil, on the life of its sole shareholder, Mr. X. Following the receipt of $500,000 under the policy on Mr. X’s death, Canco reduced an outstanding loan by $200,000 and paid a $250,000 capital dividend to the estate, retaining the balance of $50,000 in working capital. The estate sold the Canco shares to Ms Y, an unrelated Canadian resident. Alternatively, Mr. X owned Canco indirectly through Holdco, so that the estate of Mr. X sold Holdco to Ms Y. Could Ms Y eventually receive a capital dividend from the CDA balance of either Canco or Holdco? CRA responded:
[T]he CDA balance of Canco would not consist of amounts described in paragraphs 83(2.2)(a) to (d) (such CDA balance being only attributable to an insurance policy proceeds in this scenario). Consequently, subsection 83(2.1) would not apply to deem a capital dividend received by Ms Y … to be a taxable dividend.
After indicating that s. 83(2.1) also would not apply in the Holdco scenario, CRA stated:
Finally, subsection 83(2.3) provides that subsection 83(2.1) will not apply to a capital dividend paid by a corporation in order to distribute life insurance proceeds which were received by it and included in its capital dividend account as a consequence of the death of a person. Subsection 83(2.1) does not apply where a capital dividend funded by life insurance proceeds is paid to an individual either directly or through a holding corporation by reason of the exception provided in paragraph 83(2.2)(a).
…Thus, assuming that Canco’s assets consist only of $50,000 cash which is funded by life insurance proceeds, the provision 83(2.3) could apply to a capital dividend equal to this amount.