Summary of New RDTOH Rules
General
Starting on January 1, 2019, Canadian controlled private corporations earning investment income will be subject to a new set of complex tax rules relating to their refundable dividend tax on hand ("RDTOH") balance. The new rules restrict the ability for corporations to recover their RDTOH balance through the payment of eligible dividends in certain circumstances The new rules could increase the tax cost to individual shareholders when they receive dividends from their corporations by constraining the ability to pay eligible dividends which are taxed at a lower rate than non-eligible dividends. The tax cost ranges from 6% to 14% based on the particular province.
Transitional Rules
Under the new regime, the pre-2019 RDTOH account will be split into an eligible RDTOH pool and a non-eligible RDTOH pool.
Transitional rules will apply to calculate the opening eligible RDTOH pool and non-eligible RDTOH pool of a corporation. In general terms, the opening eligible RDTOH pool of a corporation will have a one-time addition equal to the lesser of:
- its existing RDTOH balance at the time of the transition; and
- 38.33% of its GRIP balance at the time of the transition.
The pre-2019 RDTOH balance of a corporation not added to its eligible RDTOH pool pursuant to the transitional rules (described above) will be added to the non-eligible RDTOH pool of the corporation.
Go-forward Rules
The following taxes will be added to the non-eligible RDTOH pool of a corporation: refundable Part I taxes paid on investment income (including taxable capital gain) earned, refundable Part IV taxes paid on a non-eligible dividend received from a corporation that is not 'connected' with the recipient corporation and Part IV taxes paid on a non-eligible dividend received from a 'connected' corporation to the extent that the dividend results in a dividend refund to the payor corporation. A corporation will be entitled to a refund of the non-eligible RDTOH pool upon the payment to its shareholder(s) of a non-eligible dividend.
The following taxes will be added to the eligible RDTOH pool of a corporation: refundable Part IV taxes paid on an eligible dividend received from a corporation that is not 'connected' with the recipient corporation and Part IV taxes paid on an eligible dividend received from a connected corporation to the extent that the dividend results in a dividend refund to the payor corporation. Subject to the ordering rule set out in the next sentence, a corporation will be entitled to a refund of the eligible RDTOH pool upon the payment to its shareholder(s) of an eligible dividend. However, a corporation will only be entitled to a refund of RDTOH on the payment of an eligible dividend if the non-eligible RDTOH pool has been fully refunded (i.e., is $0).
Application of the New RDTOH Regime
General
The new RDTOH rules can affect a corporate group of companies in a number of situations. This includes situations where: there is general rate income pool ("GRIP") in a lower tier entity corporation and RDTOH in an upper tier corporation; there is GRIP, but nominal RDTOH, in a corporation or corporate group of companies; and there is a plan to pay eligible dividends to individual shareholders in the short term or within the next few years.
Example
Tax Problem
An example of one scenario is as follows: Pessy and Anna, equally, own all of the shares of a holding company ("Holdco"). Holdco owns all of the shares of an operating company ("Opco"). Holdco has a GRIP balance of $0 and RDTOH balance of $1,000,0000. Opco has a GRIP balance of $3,000,000 and RDTOH balance of $0. The year-end of both companies is December 31, 2018.
The transitional rules will apply to calculate the opening eligible RDTOH pool of Holdco to be $0 and non-eligible RDTOH pool of Holdco to be $1,000,000 as follows. The opening eligible RDTOH pool will have an addition equal to the lesser of:
- its existing RDTOH (i.e., $1,000,000); and
- 38.33% X the GRIP balance (i.e., GRIP balance is $0).
Thus, the addition to Holdco's eligible RDTOH pool will be equal to $0.
Pursuant to the transitional rules, Holdco's pre-2019 RDTOH balance (since it is not added to its eligible RDTOH pool) will be added to its non-eligible RDTOH pool. Therefore, Holdco's non-eligible RDTOH pool will be equal to $1,000,000.
As such, even if Opco moves up GRIP to Holdco in 2019, Holdco will not be entitled to a refund of RDTOH on the payment of an eligible dividend to Pessy and Anna until its $1,000,000 non-eligible RDTOH pool has been fully refunded (i.e., is $0). This is a bad result. On the other hand, the payment of a non-eligible dividend (in contrast to an eligible dividend) by Holdco to Pessy and Anna to 'clear out' the non-eligible pool will give rise to more taxes. This is also a bad result.
Tax Planning
In our example, simple tax planning can be undertaken with the result that Holdco's pre-2019 RDTOH balance can be added to its eligible RDTOH pool (not its non-eligible RDTOH pool). The planning entails Opco paying an eligible (safe income) dividend to Holdco in the amount of $2,608,925 in 2018. This will cause Holdco's GRIP balance to be equal to $2,608,925 and eligible RDTOH pool to be equal to $1,000,000.
More specifically, the transitional rules will apply to calculate the opening eligible RDTOH pool of Holdco to be $1,000,000 as follows. The opening eligible RDTOH pool will have a one-time addition equal to the lesser of:
- its existing RDTOH balance (i.e., $1,000,000); and
- 38.33% X the GRIP balance (i.e., GRIP balance is $2,608,925).
No amount will be added to Holdco's non-eligible RDTOH pool.
Now Holdco can pay an eligible dividend to Pessy and Anna in the amount of $1,000,00 and receive a refund of RDTOH.
If the year-end of the companies was not December 31 (i.e., not a calendar year-end) similar-type planning in 2019 may be undertaken in certain circumstances.
Takeaway
Tax advisors and counsel should carefully analyze the new RDTOH regime with their clients' corporate holdings, GRIP and RDTOH balances on hand, and effect the appropriate tax planning, to prepare for the new RDTOH regime.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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