RDTOH is the abbreviation for refundable dividend tax on hand – a tax mechanism used to achieve integration. The ultimate goal of integration is for income to be taxed at the same overall rate by the time it is in an individual’s hand, whether it was initially earned within a corporation or earned directly by the individual.
These changes will take effect in the first taxation year beginning after 2018.
HOW DOES RDTOH WORK NOW?
Investment income is taxed at about the highest personal tax rates in a corporation: 50.17% in Ontario, 38.33% on Canadian dividends
A portion of that tax is refundable: 30.67% or the full 38.33% on Canadian dividends.
Taxes are refunded to the corporation at a rate of 38.33%, $38.33 for every $100 of taxable dividends paid to its shareholders. Dividend refunds are only issued up to the available RDTOH balance.
Currently, this refund rate is the same regardless of whether the dividends paid are eligible or non-eligible.
HOW IS RDTOH CHANGING?
The changes will take effect in the first taxation year beginning after 2018. There will now be two pools of RDTOH, eligible and non-eligible (ERDTOH and NERDTOH).
The existing RDTOH pool will be divided into eligible and non-eligible RDTOH:
- Eligible RDTOH will be deemed to be the lesser of RDTOH balance at the end of the last taxation year and 38.33% of the ending GRIP balance.
- Any remaining amount of the existing RDTOH pool will be deemed to be non-eligible RDTOH.
A few other key points to keep in mind:
- An RDTOH refund will generally only be available when a private corporation pays non-eligible dividends. The exceptions being when RDTOH is accrued from eligible portfolio dividends received by a CCPC or if dividends are received from a connected corporation where ERDTOH was refunded to the connected corporation;
- Eligible dividends that are paid when the corporation only has non-eligible RDTOH will not result in a dividend refund;
- Eligible RDTOH will track refundable taxes paid under Part IV on eligible dividends received;
- Eligible RDTOH can be recovered by paying either eligible or non-eligible dividends;
- An ordering rule required a non-eligible dividend payment will first generate a refund from its non-eligible RDTOH account, then its eligible RDTOH account.
This table takes uses the highest marginal Ontario tax rates for 2018.
As seen above, unless there is an eligible RDTOH pool available, the overall tax rate on dividends paid out of investment proceeds within a corporation is increasing by 6%. This is a significant increase.
If eligible dividends are paid, without an eligible RDTOH pool, the overall tax rate increase will be 18%. This is an example of why it is becoming more and more important to consult a tax professional when you are deciding how to report payments taken out of your corporation.
This change to the RDTOH regime is in line with the other changes to passive income that were introduced in the 2018 Federal Budget; the overall tax rate on investment income in a corporation is increasing, as the CRA is continuing to discourage investing within a corporation.
Some tax planning points we are suggesting to our clients include:
- Maximize eligible dividends paid prior to changes to the highest extent possible;
- Increase investment in CCPCs to create ERDTOH;
- Choose investment in long-term capital investments rather than income distributing investments;
- Consider investing in life insurance plans.