Refundable Dividend Tax on Hand (RDTOH) is a tax mechanism designed by the Canada Revenue Agency (CRA) to prevent business owners from hiding passive investment income inside a corporation to defer taxes. When your Canadian-controlled private corporation (CCPC) pays taxable dividends out to shareholders, it can receive a dividend refund of roughly 38.33% of the amount paid.
Operating a holding company (holdco) in Canada is a very popular strategy for business owners looking to invest surplus cash. However, the Canadian tax system is built on a principle called “integration.” This means you should generally pay the same amount of tax whether you earn investment income personally or through a corporation. Whether your business is headquartered in Vancouver, Calgary, or Toronto, the federal tax rules regarding passive income apply uniformly across the country. 📍 To stop individuals from using their lower-taxed corporations as personal tax shelters, the CRA imposes a very high upfront tax rate on passive income, which is then partially refunded through the RDTOH account when dividends are paid out. Managing these complex corporate tax accounts often requires the expertise of a local corporate tax law firm or a Chartered Professional Accountant (CPA).
Step-by-Step Process: How RDTOH Works in Canada
Understanding the flow of money and taxes in a CCPC can seem overwhelming at first. The RDTOH is not a physical bank account; it is a notional tracking account on your corporate tax return (T2). Here is how the process generally unfolds over a financial year.
Step 1: Earning Passive Investment Income
The cycle begins when your private corporation earns passive income. 💸 This includes rental income from real estate, interest from GICs or bonds, taxable capital gains, and portfolio dividends from publicly traded companies. Income from an active business operations (like running a retail store) does not generate RDTOH.
Step 2: Paying Upfront Corporate Tax
To discourage tax deferral, the CRA hits this passive income with a high upfront tax rate, usually hovering around 50% depending on your specific province. A portion of this high tax is added to your corporation’s RDTOH tracking account. For portfolio dividends received from other Canadian corporations, you pay a special refundable tax called Part IV tax, which is also added to the RDTOH balance.
Step 3: Distinguishing Between ERDTOH and NERDTOH
Since 2019, the CRA split the RDTOH account into two separate pools. 🔍 Eligible RDTOH (ERDTOH) generally tracks taxes paid on eligible portfolio dividends, while Non-Eligible RDTOH (NERDTOH) tracks taxes paid on other passive income like interest and rental income. You must keep strict track of both, as they dictate the type of dividend you must pay out to trigger a refund.
Step 4: Declaring and Paying a Dividend
To get the upfront tax money back from the CRA, your corporation must declare and pay a taxable dividend to its shareholders. Your corporate lawyer will draft a director’s resolution formally declaring the dividend. The shareholders will then report this dividend on their personal T1 tax returns and pay personal tax on it.
Step 5: Claiming the Dividend Refund
When your accountant files the corporation’s T2 tax return at the end of the fiscal year, they will report the dividends paid. 📝 The CRA will calculate your “dividend refund,” which is generally $1 for every $2.61 of taxable dividends paid out, up to the maximum balance sitting in your RDTOH accounts. This refund reduces your corporation’s overall tax bill or results in a cash refund cheque.
How Much Does Corporate Tax Compliance Cost?
Managing a holding company with active investment portfolios involves unavoidable professional fees. Here is a general breakdown of what Canadian business owners can expect to pay.
- Annual Corporate Tax Prep (T2): A CPA generally charges between $1,500 CAD and $3,500 CAD to file a holding company tax return with RDTOH schedules.
- Legal Annual Resolutions: A corporate law firm typically charges $250 CAD to $500 CAD to maintain the minute book and draft dividend resolutions.
- Tax Planning Consultations: If you need a tax lawyer to restructure your corporate group to optimize dividend flows, expect hourly rates between $400 CAD and $800 CAD.
How Long Does the Refund Process Take?
Cash flow planning is critical when dealing with RDTOH. You must pay the dividend to yourself before your corporation’s fiscal year-end to claim the refund for that year. Once the T2 return is filed, it generally takes the CRA 2 to 4 months to process the return and issue the dividend refund cheque or apply it against your corporate tax balance.
Comparing ERDTOH and NERDTOH Pools
The 2019 tax changes made paying out dividends more complicated.
| RDTOH Pool | What it Tracks | Required Action for Refund |
|---|---|---|
| Eligible RDTOH (ERDTOH) | Part IV tax paid on eligible portfolio dividends. | Must pay out Eligible Dividends to shareholders. |
| Non-Eligible RDTOH (NERDTOH) | Taxes paid on interest, rents, capital gains, and non-eligible dividends. | Must pay out Non-Eligible Dividends to shareholders. |
Frequently Asked Questions (FAQ)
What is Part IV tax in Canada?
Part IV tax is a 38.33% refundable tax a private corporation pays when it receives portfolio dividends from unconnected Canadian corporations. It is fully refunded when the corporation passes those dividends down to its personal shareholders.
Can an active business generate RDTOH?
No. Income earned from active business operations (like manufacturing or consulting) is taxed at lower active business rates and does not generate RDTOH. RDTOH only applies to passive investment income.
Do I have to pay out all my RDTOH every year?
No. You can choose to leave the funds in the corporation and let the RDTOH balance carry forward to future years. You only trigger the refund when you eventually decide to pay a dividend.
Can a lawyer help me calculate my dividend refund?
While a corporate lawyer is essential for drafting the legal dividend resolutions and maintaining your minute book, calculating the exact RDTOH refund is an accounting task best handled by your CPA.
Why is the upfront tax on passive income so high?
The CRA imposes a high initial tax to remove any incentive for wealthy Canadians to shelter their personal investments inside a corporation simply to defer paying personal income taxes.
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