Canada: Tax Integration Mechanisms: Refundable Dividend Tax On Hand (RDTOH), Aggregate Investment Income & The Part IV Tax

Last Updated: November 23 2017
Article by David Rotfleisch

Introduction – Refundable Dividend Tax On Hand("RDTOH")

RDTOH isn't simple and isn't for everybody. In fact, the dividend refund provisions in subsection 129(1) of the Income Tax Act (the "Act") only apply to a "private corporation". To be a "private corporation" for Canadian tax purposes the corporation must be: a) not public; b) not controlled by a public corporation/federal Crown corporation; and c) resident in Canada. Eligibility for refundable dividends is defined by exclusion so it applies to both Canadian Controlled Private Corporations ("CCPCs") and private corporations.

RDTOH is a tax integration mechanism, meaning that it is one of several provisions designed to tax corporations and the subsequent distributions to shareholders (dividends) at the same rate as if the income was earned directly by an individual. In other words, tax integration attempts to both eliminate certain tax advantages received by using a corporation and not to penalize taxpayers who earn corporate income.

Refundable dividend tax on hand accumulates in a corporation that earns passive (investment) income until a taxable dividend is paid out to shareholders (thereby being taxed in the shareholder's hands). The corporation will then recover a percentage of the dividends paid from its RDTOH account. This article will examine some of the key pieces of the integrated tax system including Aggregate Investment Income, Part IV Tax, and the RDTOH account.

Aggregate Investment Income–What is it?

Aggregate investment income is a type of passive income earned by a private corporation and is taxed differently than active business income. Aggregate Investment Incomeis calculated by determining two amounts: "A" and "B," summing them, and netting them against losses from property sources. As such, it is possible for a corporation to have no aggregate investment income in any given taxation year.

The amounts in "A" and "B" are defined in section129(4)(a) and 129(4)(b) of the Income Tax Act respectively. Summarized briefly, "A" amounts are taxable capital gains in excess of capital losses. Capital loss amounts include losses accrued in the current taxation year as well as losses accrued in other taxation years that were either carried back or forward to the current year. The "B" amount is made up of any income from property with four specific exclusions, the most notable of which is the deductible dividend exclusion.

Part IV Tax – What is it?

Part IV tax is all about dividends as Part IV tax is 38.33% of a corporation's "assessable dividends." Assessable dividends are dividends received by a private corporation or a subject corporation from non-connected corporations to the extent that they are deductible under section 112 or 113 of the Income Tax Act. A section 112 deduction is generally available for taxable dividends received from a taxable Canadian corporation. A section 113 deduction is available for dividends received from foreign affiliates under certain conditions.

Refundable Dividend Tax On hand – What is it?

A corporation's RDTOH for the year is defined in section 129(3) of the Income Tax Act and is made up of fours parts: (a); (b); (c); and (d). RDTOH is the amount by which the total of (a), (b), and (c) exceed (d). Parts (a) through (d) are discussed below in the following order: (c); (b); (d); and (a). Calculating RDTOH is not an easy task, and some of the amounts are easier to determine than others. The computation of RDTOH is cumulative and any RDTOH from the previous taxation years is carried forward by part (c). In addition, any Part IV tax payable by the corporation for the year is included under part (b). The total of amounts (a) through (c) must exceed (d) where (d) is the dividend refund for the preceding tax year.

The amount in part (a) only applies to corporations that have been CCPCs throughout the year and is determined by taking the least of three amounts: (i); (ii); and (iii). Determining aggregate investment income is essential for calculating RDTOH for CCPCs as the amount in (i) may include up to 30.67% of aggregate investment income. The amount in (ii) looks to two key corporate tax concepts, the small business deduction and the foreign tax deduction. The amount in (ii) is 30.67% of the corporation's taxable income that exceeds the amount of income available for the small business deduction andthe deducted foreign tax amounts for business and non-business income.

Another key premise is that the definition of RDTOH serves to limit the recoverable tax available to the amount of Part 1 tax that was payable in any given year.The amount in (iii) equals Part 1 tax so if the (iii) amount is the smallest amount, only Part 1 tax payable can be added to RDTOH.

In other words Refundable dividend tax on hand is made up of the cumulative amount of investment income earned by a corporation.

Dividend Refund Provision – How does it work?

The dividend refund provision is under subsection 129(1) of the Income Tax Act and allows the CRA to refund to corporations (without application) the lesser of the corporation's RDTOH account or 38.33% of all taxable dividends paid by the corporation. For example, if a corporation has an RDTOH account balance of $350 and pays $1000 of taxable dividends to its shareholders the corporation will receive the entire RDTOH account balance as a refund. The RDTOH amount is used as 38.33% of $1000 is $383 which exceeds the RDTOH balance of $350. The lesser figure is chosen per the dividend refund rule.

Tax Tips - Refundable Dividend Tax On Hand

The dividend refund rules are complicated. The definition of RDTOH may seem strange and unnecessarily complex; however, there are policy rationales for how all amounts are calculated under 129(3) of the Income Tax Act. While the policy rationale behind the RDTOH definition is beyond the scope of this article, it goes to show that the provisions of the Income Tax Act are often the result of careful planning on the part of the Ministry of Finance. In addition, the RDTOH account is one of several important accounts for corporate tax planning purposes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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