Minimize your tax on investment income in Canadian-controlled Private Corporations (CCPCs) through the RDOH
As a Canadian-Controlled Private Corporation owner, you’ve been enjoying all the benefits and tax incentives that come along with your company. Should you reinvest your funds in CCPCs, what is the tax rate?
The tax rate for investment income in CCPCs
- What is investment income?
Investment income includes capital gain and property income, for example, interest, rental income and royalty.
- What is the tax rate for investment income in CCPCs?
Compared to active income taxed at 9% at the federal level, investment income is taxed at 38.33% for dividends received and 38.67% for any investment income other than dividends. The combined federal and provincial tax rate can be over 50% for CCPCs.
The 2022 investment tax rate for Canadian-controlled Private Corporations is:
Non-connected company dividends
Interest, rental, royalty
- How to minimize your tax on investment income – RDOH?
RDOH is an abbreviation of “refundable tax on hand.” The RDTOH accounts are notional accounts that keep track of refundable taxes that a private corporation can get back from the federal government. Only private corporations can open RDTOH accounts. There are two RDTOH accounts: an eligible RDTOH account and a non-eligible RDTOH account.
When the corporation pays a dividend, it can get a tax refund. How can RDOH help you reduce your taxes? Let’s talk about it based on the category for investment income.
Dividends from non-connected company
Dividends from non-connected corporations, for example, portfolio dividends, are exempted from part I tax, but part IV tax needs to be paid. Part IV tax is a federal tax only; the rate is 38.33%. For example, if CCPC receives $10,000 in dividends from a non-connected company, the Part IV tax is $3,833. However, if the CCPC pays taxable dividends to its shareholder, the entire $3,833 can be refunded, resulting in a zero tax on dividends received.
How does it work? The part IV tax paid by CCPCs becomes a refundable tax on hand (RDOH), which is refunded if dividends are subsequently paid out to its shareholders. How much is the refund? Dividend’s refund equals the lesser of:
- 38.33% of dividends paid out
- The RDOH balance of the company
For example, the company GUI is a CCPC:
- the beginning balance of RDHO is 0,
- the Canadian eligible dividends received is 20,000
- the non-eligible dividends received is 10,000
- Its RDOH balance is: 11499
- GUI pay shareholder 20,000 non-eligible dividends
Part IV tax paid will be added to non-eligible RDOH if dividends received are non-eligible dividends; part IV tax paid will be added to eligible RDOH if dividends received are eligible dividends, for example, portfolio dividends.
The RDOH before dividends paid out is:
The total RDOH balance is:11,499
How much is the refund?
Dividend’s refund equals the lesser of:
- 38.33% times 20,000 = 7666
- The RDOH balance of the company: 11,499
In this case, the refund is 7,666.
In most chance, CCPCs will pay non-eligible dividends. If the company pays non-eligible dividends, the refund will be moved out from the company’s non-eligible RDOH first. If the non-eligible RDOH account isn’t enough, the refund will come from the eligible RDOH account. However, The eligible dividends refund can be deducted only from eligible RDOH.
After the refund is taken out, the RDOH ending balance is:
Aggregate investment income (AII)-Rental, Royal and Interest
Rental, royalty, and interest will be included in the taxable income of CCPC. As passive investment income, the Federal tax rate is 38.67%; if combined with provincial tax, the rate is about 50%. Please don’t be scared. The good news is 30.67% of part I tax paid on AII will be added to non-eligible RDOH as a tax credit.
When non-eligible dividends are paid to shareholders, the refund is the lesser of
- 38.33% of non-eligible dividends paid
- RDOH on hand
This will result in a corporate tax rate of 8% federally. If a provincial tax rate, such as Alberta’s, is combined with the corporate tax rate, interest, royalty, and rental income become subject to a lower rate of 16%.
Aggregate investment income (AII)- Capital gain
Capital gains/losses earned within a corporation are AII. For example, capital gain from real property is subject to the part I tax and taxed at the same rate as rental, interest, and royalty income. However, only 50% of the Capital Gains fewer capital losses are included in taxable income as a taxable capital gain for the part I. The allowable capital loss can only be applied to capital gain. The federal government tax capital gain at 19.34%. If combined with the provincial tax rate, for example, Alberta, the corporate level tax rate is 23.24%
The 15.34% will be added to non-eligible RDOH as a tax credit. If non-eligible dividends were paid, the tax rate for capital gain could be 4% federally, and the combined rate is 8% in Alberta.
How about the part of your capital gain that isn’t taxable?
The non-taxable portion of the capital gains is added to the corporation dividend account (CAD), a notional account that keeps track of tax-free items earned by the private corporation. The capital dividends paid out to shareholders through the Capital Dividend Account won’t be taxed-either corporate or personal. CDA is a powerful estate tax planning tool for shareholders of CCPCs.
A private corporation can only pay a capital dividend if there is a positive balance in the corporation’s capital dividend account (CDA). Before paying the capital dividend, an election 83(2) must be filed.
Tax is complex. How can you minimize tax? Planning and structuring your business is crucial. Speak with your tax advisors about your tax situation.