The February 27, 2018 Federal Budget proposes changes to the refundable dividend tax on hand (RDTOH) regime.
Currently, the goal of the Canadian tax system is to achieve integration between the shareholder and the private corporation. Generally, this means that no matter how income is taxed in the corporation, by the time the income is in the shareholder’s hands, the total tax liability between the two should be the same as if the individual earned it personally.
What is the Refundable Dividend Tax on Hand?
RDTOH is the mechanism that was built into the tax system to achieve integration with investment income, since corporate tax rates are typically lower than personal tax rates. Therefore, corporations pay an “extra” tax on investment income on top of the regular corporate tax, mimicking what an individual in the highest tax bracket would pay if that individual invested personally. This additional tax is kept track of in the corporation’s RDTOH account and gets refunded when the corporation pays out a taxable dividend to its shareholder(s). For Canadian Controlled Private Corporations’ (CCPCs) tax years that begin prior to 2019, RDTOH can get refunded regardless of whether the dividend is eligible or non-eligible (corporate income taxed at the lower small business rate). Eligible dividends are taxed at a lower rate than non-eligible.
Proposed Changes to the RDTOH Regime
For tax years beginning after 2018, Budget 2018 proposes changes to the RDTOH system by allowing the recovery of RDTOH only on the payment of non-eligible dividends, in many cases. The proposed system will introduce eligible and non-eligible RDTOH accounts for CCPCs. Dividends earned subject to the Part IV tax (portfolio dividends) will be included in the eligible RDTOH pool, whereas all other investment income that generates RDTOH will go towards the non-eligible RDTOH pool.
A refund will be available from the eligible RDTOH account on payment of an eligible dividend and a refund will be available from the non-eligible RDTOH account on payment of a non-eligible dividend. If the non-eligible RDTOH account is fully utilized, then a non-eligible dividend can be paid to recover the eligible RDTOH account balance. Eligible dividends that are paid when the corporation only has a non-eligible RDTOH account would not result in a RDTOH refund.
Transitional rules will be in place to allow the RDTOH refunds on eligible dividends to the extent of general rate income pool (GRIP) balances arising in taxation years that begins prior to 2019. This means that, for CCPCs, the lesser of its existing RDTOH balance and 38 1/3 percent of its GRIP balance will be allocated to its eligible RDTOH account. The remaining balance, if any, will be part of the non-eligible RDTOH account. For corporations other than CCPCs, all of the existing RDTOH balance will be designated to its eligible RDTOH account.
Under the current rules, corporations would generally pay eligible dividends first, and then non-eligible dividends if necessary because of the lower personal tax rate on eligible dividends. Once these new rules are applicable (taxation years beginning after 2018) there will likely be a preference to pay non-eligible dividends first to the extent that there is only a non-eligible RDTOH account available in order to recover the RDTOH in the corporation.
Contact us today for more information on how the 2018 Federal Budget may affect you and your business.