Dividend refund rules

A dividend refund is currently available to a private corporation that pays taxable dividends in a taxation year. The amount of its dividend refund for the year is equal to the lesser of 38 1/3% of all taxable dividends it paid in the year and its refundable dividend tax on hand (RDTOH) balance at the end of the year.

A dividend refund is available whether a corporation pays eligible dividends or non-eligible dividends in a taxation year. Eligible dividends are generally paid from a corporation’s active business income that was taxed at the general corporate income tax rate, including from eligible portfolio dividends received by the corporation (i.e., eligible dividends received from non-connected corporations). Non-eligible dividends are generally paid from a corporation’s active business income that was taxed at the small business tax rate, including non-eligible dividends received by the corporation, or from its passive investment income (excluding the non-taxable portion of capital gains, and eligible portfolio dividends).

In general, a private corporation’s RDTOH balance at the end of a taxation year consists of the refundable portion of Part I income tax that it paid on investment income (equal to 30 2/3% of its aggregate investment income, subject to certain limits) and any tax it pays under Part IV of the Income Tax Act on dividends received from private corporation (Part IV tax), and is reduced by its dividend refunds for preceding taxation years.

The budget proposes to generally limit the payment of dividend refunds to cases where a private corporation pays non-eligible dividends. An exception will be provided in respect of RDTOH that arises from eligible portfolio dividends received by a corporation, in which case the corporation will still be able to obtain a dividend refund on the payment of eligible dividends. To accomplish this, the budget proposes to compute a private corporation’s dividend refund by reference to two new balances – the “eligible refundable dividend tax on hand” (eligible RDTOH) and “non-eligible refundable dividend tax on hand” (non-eligible RDTOH) balances – which will replace the existing RDTOH balance.

A private corporation’s dividend refund for a particular taxation year will be equal to the total of the following three amounts:

• Amount 1: the lesser of
  • 38 1/3% of the total of all eligible dividends it paid in the year, and
  • its eligible RDTOH balance at the end of the year;
• Amount 2: the lesser of
  • 38 1/3% of the total of all non-eligible dividends it paid in the year, and
  • its non-eligible RDTOH balance at the end of the year; and
• Amount 3*: either
  • if 38 1/3% of the total of all non-eligible dividends it paid in the year exceeds its non-eligible RDTOH balance at the end of the year, the lesser of  
    • the amount of the excess, and
    • the amount by which its eligible RDTOH balance at the end of the year exceeds Amount 1, if any, determined for the year 
  •  in any other case, nil. 

*The computation above will effectively require a private corporation to obtain a refund from its non-eligible RDTOH balance before it obtains a refund from its eligible RDTOH balance, when it pays a non-eligible dividend.

A corporation’s eligible RDTOH balance at the end of a taxation year is the amount, if any, by which the total of

• its Part IV tax for the year in respect of
  • eligible dividends received in the year from non-connected corporations, and
  • taxable dividends received in the year from connected corporations, to the extent the dividends caused a dividend refund to those corporations from their eligible RDTOH balance, and 

• where it was a private corporation at the end of its preceding taxation year, its eligible RDTOH balance at the end of that preceding year,

exceeds 

• the portion, if any, of its dividend refund from its eligible RTDOH balance (i.e., the total of Amount 1 and Amount 3 as determined in Question 4 above) for its preceding taxation year.

A corporation’s non-eligible RDTOH balance at the end of a taxation year is the amount, if any, by which the total of 

• where it was a Canadian-controlled private corporation (CCPC) throughout the year, the refundable portion of the Part I income tax that it paid on investment income in the year (equal to 30 2/3% of its aggregate investment income, subject to certain limits),
• its Part IV tax for the year, excluding the amounts included above in computing its eligible RDTOH balance at the end of the year, and
• where it was a private corporation at the end of its preceding taxation year, its non-eligible RDTOH balance at the end of that preceding year, 

exceeds

• the portion, if any, of its dividend refund from its non-eligible RTDOH balance (i.e., Amount 2 as determined in Question 4 above) for its preceding taxation year.

Under a transitional rule, a corporation’s existing RDTOH balance will be allocated to its eligible RDTOH and non-eligible RDTOH balances for the first taxation year that those definitions apply to it, as follows:

• if the corporation is a CCPC throughout that first taxation year and its preceding taxation year, and did not elect under subsection 89(11) of the Income Tax Act to be considered a non-CCPC for certain purposes in either of those years:
  • its eligible RDTOH balance for the preceding taxation year will be deemed to be the amount, if any, that is the lesser of its existing RDTOH balance at the end of that preceding year* and an amount equal to 38 1/3% of the balance of its general rate income pool at the end of the preceding year (as reduced to reflect any eligible dividends paid in that previous year), and
  • its non-eligible RDTOH balance for the preceding taxation year will be deemed to be the amount, if any, of its existing RDTOH balance at the end of the preceding year* that was not allocated to its eligible RDTOH balance; and
• in any other case, its eligible RDTOH balance for the preceding taxation year will be deemed to be equal to its existing RDTOH balance at the end of that preceding year*.

*As reduced by the amount of its dividend refund for that preceding year.

The budget proposes that changes to the dividend refund rules will apply for taxation years that begin after 2018. However, the rules will also apply to a taxation year of a corporation that begins in 2018 and ends in 2019 if 

• the preceding taxation year was, because of a transaction or event or a series of transactions or events, shorter than it otherwise would have been, and
• one of the reasons for the transaction, event or series was to defer the application of the changes to the dividend refund rules, or the changes to the small business deduction rules, to the corporation. 

Where a short taxation year arises in the context of a transaction or event or a series of transactions or events that was contemplated or initiated prior to the budget announcement, the resulting short taxation year will not generally be considered to have arisen for the purpose of deferring application of these rules. Taxpayers and their representatives should maintain documentation regarding the timing and purpose of any such transactions or events. As a reminder, corporations must receive approval from the CRA to change their tax year end. To change a fiscal year end, write a letter to your tax services office asking for approval and include details explaining the reasons for the change.

The CRA provides the latest information on the proposed changes on Canada.ca. Taxpayers should check online regularly for updated forms, policies, guidelines, questions and answers, and guidance.

In the meantime, please consult the Department of Finance Canada’s Budget 2018 documents for details.