The dividend series – Dividends, Investment Income & Taxation – Part B
What does the future hold?
For taxation years beginning after December 31, 2018, all Canadian controlled private corporations (CCPCs) earning investment income must consider a new set of complex rules relating to their refundable dividend tax on hand (RDTOH) balances. These rules could increase the tax costs to individuals when distributing corporate funds from their private corporations. Before January 1, 2019, taxpayers will need to review their companies’ RDTOH balances to determine whether planning is required.
The new RDTOH regime
The 2018 federal budget announced new measures that restrict the ability to recover RDTOH through the payment of eligible dividends, with limited exceptions. This means that the cost of extracting profits from a CCPC may go up for the typical owner-manager.
Effective for taxation years beginning after December 31, 2018, the existing RDTOH account will be segregated into two new accounts:
- a non-eligible RDTOH (NRDTOH) account will track the refundable (Part I) taxes incurred on investment income earned (including taxable capital gains), and any refundable (Part IV) taxes on dividends received (net of Part IV taxes tracked in the eligible RDTOH [ERDTOH] pool)
A refund of the NRDTOH will only be available upon the payment of non-eligible dividends. In all provinces these dividends are taxed at a higher rate than eligible dividends.
- an ERDTOH account will track refundable (Part IV) taxes paid on eligible dividends received from corporations that are not connected,1 as well as eligible dividends received from connected corporations to the extent that these dividends triggered a dividend refund to the payor corporation
A refund of the ERDTOH account will only be available upon the payment of eligible dividends.
The existing RDTOH balance will be added to the NRDTOH account except for the transitional amount.
2019 transitional RDTOH amount
A CCPC’s opening ERDTOH account will have a one-time addition equal to the lesser of:
- its existing RDTOH balance
- 38.33% of the CCPC’s GRIP balance
As a result:
- the corporation’s GRIP balance must be at least 2.6 times the existing RDTOH pool in order for the entire RDTOH balance to qualify as ERDTOH, and
- if the company has an RDTOH balance, but has no GRIP balance, all of the RDTOH will be added to the NRDTOH account
How can your accountant help with the planning strategy?
These new rules will impact taxation years commencing in 2019. To prepare for the change, you should discuss with your adviser whether:
- it is possible to move the GRIP and RDTOH balances into the same company to maximize the addition to the ERDTOH account (for example, if a company has RDTOH but no GRIP, determine if the GRIP in a lower-tiered company can be moved to the higher-tiered company)
- there is a plan to distribute corporate funds to individual shareholders in the next few years because there may be an advantage to speeding up the distribution before 2019 to realize a lower effective tax rate
- for companies with GRIP, but limited RDTOH, it may make sense to trigger investment gains to create an ERDTOH account that can be used for future distributions
The 2018 Federal Budget confirmed the Canadian government’s intent to address Canadian controlled private corporations (CCPC) that earned significant investment income by targeting the Refundable Dividend Tax On Hand (RDTOH) regime. RDTOH is created from passive income earned by a CCPC and as implied in the name, is refunded to the corporation upon payment of taxable dividends. Investment income subject to the RDTOH regime is typically not added to a CCPC’s General Rate Income Pool (GRIP) from which eligible dividends are paid.
Under the historical RDTOH rules, an eligible dividend paid by CCPC could allow for a refund of RDTOH. This provided an opportunity to pay eligible dividends and still recover RDTOH created from investment income, which did not accrete to the CCPC’s GRIP from which the eligible dividend was paid. The eligible dividend would then be taxed at approximately 39 per cent personally rather than the approximate 46 per cent rate for non-eligible dividends (highest personal dividend tax rates in Ontario). Therefore, the individual is subject to a lower personal tax rate in comparison to receiving a non-eligible dividend that would otherwise be paid from passive investment income earnings, and the corporation continues to enjoy a RDTOH refund.
Under the new rules introduced in the 2018 Federal Budget, the existing RDTOH account will be split into eligible RDTOH and non-eligible RDTOH pools. RDTOH created from passive income will accrete to a CCPC’s non-eligible RDTOH account. This will be the case with most passive income apart from eligible dividend receipts. Only non-eligible dividends will result in a refund of non-eligible RDTOH balances. Further, ordering rules will also provide that amounts cannot generally be refunded from a CCPC’s eligible RDTOH account until the non-eligible RDTOH balance has been fully refunded. The character of RDTOH paid on dividends received from a connected corporation would match their payer’s eligible/ non-eligible RDTOH accounts.
The above rules will apply to taxation years beginning on or after January 1, 2019 and transitional measures have been included to compute the opening eligible RDTOH and non-eligible RDTOH balances of a CCPC. The eligible RDTOH balance will be calculated as the lesser of:
- The existing RDTOH balance at the time of the transition; and
- 38 1/3 per cent of the GRIP balance, at the time of the transition
Once the above allocation has been calculated, any remaining RDTOH would be allocated to the non-eligible RDTOH pool. Budget 2018 alludes to the fact that existing RDTOH should not be negatively affected on transition and should be in the eligible RDTOH pool. However, the transition rules included in the legislation create a problem.
How does this change play out?
For example, let us assume that Mr. A owns 100 per cent of his holding company (“HoldCo”) and the HoldCo owns 100 per cent of an operating company (“OpCo”). Furthermore, let us assume that OpCo has a GRIP balance of $10,000,000 and RDTOH of NIL while HoldCo has a RDTOH balance of $2,000,000 and no GRIP.
On transition, HoldCo will have its eligible RDTOH balance calculated as the lesser of:
- The existing RDTOH balance at the time of the transition ($2,000,000); and
- 38 1/3 per cent of the GRIP balance, at the time of the transition ($NIL)
Therefore, HoldCo’s entire RDTOH balance will be included in the non-eligible RDTOH pool and block any refund of RDTOH when GRIP dividends are paid from OpCo through HoldCo to the individual shareholder. As a result, there is no transitional relief on HoldCo’s RDTOHearned before the new legislation became law.
How to plan for transition
A simple planning decision, that can be undertaken prior to the new regime coming into effect, is to pay an eligible safe income dividend to cause the GRIP balance in HoldCo to equate to the RDTOH balance in HoldCo. To continue our previous example, OpCo would pay an eligible safe income dividend of at least $5,217,392 prior to the transition. On transition, the eligible RDTOH balance of HoldCo will now be calculated as the lesser of:
- The existing RDTOH balance at the time of the transition ($2,000,000); and
- 38 1/3 per cent of the GRIP balance, at the time of the transition ($2,000,000)
The resulting eligible RDTOH balance of HoldCo will now equal at least $2,000,000 with no amounts added to HoldCo’s non-eligible RDTOHpool. Accordingly, eligible dividends can continue to be paid from OpCo through HoldCo to the individual shareholder and still provide for a refund of HoldCo’s RDTOH balances.
Taxpayers should examine their corporate structures prior to the rules coming into force on January 1, 2019 to determine potential planning opportunities.
Corporate RDTOH Planning Opportunities
Currently, through the operation of the refundable dividend tax on hand (RDTOH) rules, a portion of the tax paid on passive income earned by a private corporation is refunded when the corporation pays dividends. The refund is available regardless of whether the dividends paid are eligible dividends (generally from active business income taxed at the general income tax rate) or non-eligible dividends (generally from passive investment income and active business income taxed at the small business tax rate).
As of January 1, 2019, changes to the RDTOH rules will limit the dividend refund to
(1) noneligible dividends paid by the corporation and
(2) Part IV tax on eligible portfolio dividends received by the corporation. What Planning Should You Consider Undertaking in 2018? If a corporation is planning to sell corporate assets in the near future or it has a holding corporation/operating corporation (Holdco/Opco) structure, there are two options that should be considered in 2018 to plan for the RDTOH rule changes.
- Where possible, corporate asset sales planned within the next year or two should be completed before the end of 2018 in order to maximize the corporation’s RDTOH balance at 2018 year end. Due to a transitional rule, a corporation’s existing RDTOH balance at 2018 year end will be allocated to its eligible and non-eligible RDTOH balances for the 2019 taxation year.
- Where a Holdco/Opco structure is in place and Opco has a balance in its general rate income pool (GRIP) and Holdco has RDTOH but low or no GRIP, consideration should be given to whether eligible dividends should be paid by the Opco to the Holdco in 2018 in order to maximize Holdco’s 2019 eligible RDTOH balance.
Non-Eligible Dividend Tax Credit Rates and Amount of Dividends That May be Received Without Incurring Tax in 2018a Current to: April 30, 2018
|Actual Dividend||Taxable Dividend||Actual Dividend|
|Québecf—Amounts received before March 28, 2018||8.18||7.05||24,417|
|Amounts received after
March 27, 2018
|Prince Edward Island||3.36||2.90||14,841|
|Newfoundland & Labrador||4.06||3.50||19,678|
*A table for 2019 will be added in Summer 2019.
This table assumes only “non-eligible dividend” income is earned and takes into account all federal and provincial taxes, surtaxes, and alternative minimum taxes, but does not include provincial premiums. The respective basic personal and dividend tax credits and provincial tax reductions, where applicable, are also included.“Non-eligible” dividends are those that are not subject to the dividend rules applying to “eligible” dividends (see table I-6). The gross-up rate for non-eligible dividends is 16%. The actual amount received is therefore multiplied by 1.16 to determine the taxable amount of the dividend.
A The federal and provincial dividend tax credit (DTC) rates in the table’s first column apply to the actual amount of the dividend received by an individual. The DTC rate can also be expressed as a percentage of the taxable dividend, as indicated in the table’s second column.
B The federal DTC rate that applies to non-eligible dividends decreased to 10.03% (from 10.52%) of taxable dividends beginning January 1, 2018. The dividend gross-up factor that applies to non-eligible dividends also decreased to 16% (from 17%) beginning January 1, 2018.
C Ontario decreased the province’s DTC rate that applies to non-eligibledividends to 3.12% (from 4.29%) of taxable dividends effective January 1, 2018.