Small Business Accounting Mistakes

Many small business owners are unfamiliar with the tax changes taking place in 2018, especially the changes related to the refundable dividend tax on hand (RDTOH).

What is RDTOH?

RDTOH is a tax mechanism used under the Canadian tax system that is built on the concept of “integration”. The purpose of the integration is for investment income to be taxed at the same rate, whether the income is earned personally or initially by the corporation. Generally, passive investment income, such as interest, rental income, taxable capital gains and portfolio dividends from foreign companies, earned by a Canadian controlled private corporation (CCPC) is taxed at a higher rate than active business income, and a portion of the higher tax can be refunded to the corporation when it distributes taxable dividends to the shareholders.

How Does it Work Currently?

Passive income earned by CCPC is taxed at a high combined corporate tax rate, 50.17% in Ontario. A portion of the taxes (i.e. 30.67% of investment income) is refundable and added to the corporation’s RDTOH account. A tax refund is also allowed on the taxable dividends paid out, at the rate of 38.33%, up to the balance of the RDTOH account. The refund rate on taxable dividends is the same regardless of whether the dividends paid out are eligible or non-eligible.

What are the New Rules?

Effective taxation years that begin after 2018, the existing RDTOH will be divided to two pools: eligible and non-eligible.

The eligible RDTOH account will be deemed to be the lesser of the existing RDTOH balance and 38.33% of the balance of the general rate income pool (GRIP). Any remaining amount of the existing RDTOH balance will be allocated to the non-eligible RDTOH.

The “non-eligible RDTOH” pool will track the refundable Part I tax on investment income, and Part IV tax on non-eligible intercompany dividends. The “eligible RDTOH” account will be created to track only the refundable Part VI tax on eligible dividends.

Here are some points of note:

  • An RDTOH refund will only be available when the corporation pays out non-eligible dividends, with an exception for the RDTOH resulted from eligible portfolio dividends received by the corporation.
  • Ordering rule: a payment of non-eligible dividend will first generate a refund from the non-eligible RDTOH account, then the eligible RDTOH account.
  • Non-eligible dividend payment result in a refund from the eligible RDTOH account only when there is no balance left in the non-eligible RDTOH account.
  • No dividend refund is allowed when the corporation with only the non-eligible RDTOH pays eligible dividend.

Some Tax Planning Points

  • Maximize eligible dividends paid prior to changes to the highest extent possible
  • Pay by way of a promissory note if the company does not have sufficient cash flow to pay out eligible dividends
  • Increase investment in CCPCs to create ERDTOH
  • Generate more capital gains to pay out capital dividends

If you require any assistance with your corporate tax and accounting needs, contact your Accountants Toronto.