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Refundable Dividend Tax On Hand (RDTOH) | David J. Rotfleisch

posted 2 years ago

 

Running an incorporated business in Canada typically comes with several tax advantages. This is why many small business owners rely on their private corporations to save for their families and future retirement. 

Most Canadian small business corporations generate two types of income—active and passive income. Companies can acquire the former through operational business activities and the latter from rents, investments and dividends.      

Prior to 2019, the first $500,000 of active business income of private corporations was eligible for a lower small business tax rate. A private corporation could also refund a portion of the tax on their passive investment income when paying taxable dividends to a shareholder. 

But since the new measures set by the Government of Canada around passive income in private corporations took effect, access to small business deduction and refundable taxes has become limited. 

Beginning 2019, Canadian-controlled private corporations (CCPCs) and other incorporated companies can make up to $50,000 of passive investment income without impacting the small business deduction. If a corporation exceeds that amount, it can lose $5 of the deduction for every $1 of its passive income. 

In addition, the rules also restrict the ability to recover tax paid on passive income. When a corporation pays eligible dividends, it may not receive a refund from its refundable dividend tax on hand (RDTOH) account. 

While these changes can be confusing and challenging, they may allow more opportunities for better corporate tax planning. Specifically, the RDTOH mechanism can provide more clarity when planning for investing in and withdrawing funds from your corporation. 

Let’s look more into what RDTOH is, why it is present in the Canadian tax system, and exactly how it works. 

 

What is a Refundable Dividend Tax On Hand?

Refundable dividend tax on hand (RDTOH) is a tax integration mechanism available to CCPCs. A CCPC is simply a Canadian corporation not controlled by a public corporation, a non-resident of Canada, or both. 

The primary purpose of RDTOH is to tax income at the same overall rate, whether you earn it directly or within a corporation. Such taxes prevent a tax deferral on investment income at the corporate level. 

So, if you’re a taxpayer who generates passive investment income through a corporation, you won’t receive a tax-deferral advantage on income tax any longer. But under certain circumstances, RDTOH allows a corporation to refund a portion of income tax paid on passive investment income. 

The refundable portion is calculated based on the aggregate investment income earned by a corporation, along with the dividends it receives from non-connected corporations. All these are added to the corporation’s RDTOH account, which monitors the refundable taxes paid to the Canada Revenue Agency (CRA).

So, with RDTOH accounts, you can track the extra tax you’re paying on investment income. It also protects your right to claim a tax credit every time you pay a taxable dividend to a shareholder. However, there are now two pools of RDTOH: eligible and non-eligible. 

Eligible Refundable Dividend Tax On Hand (ERDTOH)

The eligible RDTOH (ERDTOH) will track refundable taxes paid on eligible dividends received under Part IV of the Income Tax Act.  This account will be refundable by paying either eligible or non-eligible taxable dividends. Also, a corporation can only acquire a dividend refund from this account if there’s no remaining balance left in the NERDTOH. 

Non-Eligible Refundable Dividend Tax On Hand (NERDTOH)

The non-eligible RDTOH (NERDTOH) will track the refundable taxes paid on passive investment income except for the corporation’s eligible dividends. This account will only be recoverable upon the payment of non-eligible dividends. 

Note that a private corporation can only create RDTOH if they generate and report passive income. They can do it by acquiring capital gains in your corporate portfolio, receiving dividends or the income distributions from a CI Corporate Class or a pooled trust. 

 

What is Aggregate Investment Income?

Sometimes referred to as the refundable portion of Part I tax, aggregate investment income (AII) is a passive income. A private corporation generates this from property income, net taxable capital gains and portfolio dividends.

It is calculated by first adding the net taxable capital gains and total income from the property. Then deduct the sum from the business losses and related expenses for the year from property resources. 

AII is taxed depending on the province where the corporation carries on business. So far, the highest personal tax rate in a corporation is 50.17% in Ontario. 

The calculation for the tax rate of AII is also reliant on three adjustments:

  1. The small business deduction on CCPCs is not applicable.
  2. It does not qualify for a general corporate rate reduction.
  3. It is subject to an additional refundable tax of 6.67%. 

A private corporation pays 30.67% of the entire AII amount, which will go into the corporation’s RDTOH account. 

Note that the total federal tax rate on investment income is 38.66%. However, when considering the RDTOH in the effective tax rate paid by a private corporation, the federal government’s net of tax on AII is 8%. 

 

What is Part IV Tax?

Meanwhile, Part IV Tax refers to a private corporation’s assessable dividends. These are amounts paid as dividends or intended as payment of dividends that are deductible under section 112 or 113 of the Income Tax Act

Dividends eligible for deduction under section 1112 are taxable dividends received from another taxable Canadian corporation or a corporation resident in Canada controlled by the recipient. Note that these are only subject to Part IV tax when the corporation receives a dividend refund for paying the dividends. 

On the other hand, dividends deductible under section 113 are dividends received from foreign affiliates under certain conditions. 

Suppose the criteria for Part IV Tax apply; the corporation has to pay the tax at a rate of 38.33%. The entire amount is then added to the RDTOH account and becomes refundable.

Questions to Ask Before Hiring A Tax Lawyer

What’s your area of expertise, and how long have you practiced law?

You would want to hire a tax lawyer who has expertise in tax laws concerning your situation. But even if a lawyer specializes in that area, you also have to ensure that they have rich experience in the field. Make sure to ask about their area of specialization and how long they’ve been practicing it.  

Has there been a grievance or a lawsuit filed against you?

It’s essential to hire a reputable and honest tax lawyer. Be sure to check on their background. You can also ask whether they were a grievance or a lawsuit filed against you. Even if there was one, it doesn’t mean they are dishonest. 

How quickly do you respond to emails or calls promptly?

It’s essential to contact your lawyer as quickly as possible. Ask how promptly they respond to calls or emails. The last thing you would want is to have a lawyer you cannot reach out to when you’re having tax problems. 

Are your fees fixed or hourly?

You would want to know if you can afford the lawyer’s services. Make sure to ask whether the lawyer’s fees are fixed or based on the number of hours they work on your case. Being transparent with payment will ensure good faith between the lawyer and you.

 

If you have questions about RDTOH, Aggregate Investment Income, Part IV tax, or any corporate tax provisions, contact our expert Toronto tax lawyers from Taxpage today!

 

“Did you know that RDTOH is a tax integration mechanism? In other words, the goal of tax integration is to eliminate certain tax benefits obtained by using corporations and not penalize taxpayers who earn corporate income.”

– Taxpage

How Does Dividend Refund Provision Work?

As discussed above, the RDTOH account accumulates the tax paid on aggregate investment income and the assessable dividends under Part IV. 

When a corporation pays out a taxable dividend and there’s a positive balance in the RDTOH account, the corporation will receive a dividend refund at a rate of 38.33% of all the taxable dividends paid in a year. 

Let’s say your corporation has an existing RDTOH balance of $580 and pays taxable $2000 to shareholders. The dividend refund is equal to the lesser of: 

  • The RDTOH balance of $580 at the end of the year
  • 38.33% of the taxable dividends paid in the year of $766 (38.33% x $2,000)

In this case, the CRA will refund your entire RDTOH account balance of $580 since the lesser figure is used following the dividend rule. 

Meanwhile, suppose the corporation does not have an RDTOH balance. In that case, there will be no dividend refund or other tax relief forms for reporting and paying dividends. This will result in double taxation. 

Need To Learn More? Contact Taxpage Today!

Understanding how the RDTOH mechanism works is helpful when making corporate investment decisions. However, rules surrounding dividend refunds can be complicated. You can visit Taxpage for information and tips on tax planning. We also offer tax solutions and consultation for individuals and businesses. Contact us today and see how we can help you.

 

Refundable Dividend Tax On Hand (RDTOH) FAQs

Are eligible dividends subject to Part IV tax?

Yes, Part IV tax applies to eligible dividends from connected Canadian corporations and foreign affiliates.

What is the purpose of an additional refundable tax?

An additional refundable tax is like a tax prepayment on the investment income. It’s intended to ensure the federal tax on the income is high enough to prevent corporations from using tax advantages of corporations on passive income.

How is the dividend refund calculated?

You can calculate dividend refunds in several ways. One method open to Canadian private corporations with RDTOH balances is to apply a dividend refund of 38.33%, accumulating aggregate investment income and accessible dividends.

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