2019 RDTOH PLANNING, DON’T BE SCARED
Halloween came early this year, with the 2018 Federal Budget in February confirming the government’s intent to address investment income earned within a Canadian controlled private corporations (CCPC) by targeting the Refundable Dividend Tax On Hand (RDTOH) regime. RDTOH is created from passive income streams (dividends, interest, capital gains) earned by a CCPC and is refunded to the corporation upon payment of taxable dividends to shareholders. Investment income subject to the RDTOH regime is typically not added to a CCPC’s General Rate Income Pool (GRIP) from which eligible dividends are paid. The significance of GRIP is the payment of eligible dividends to shareholders which are taxed at a much lower rate on their personal returns than non-eligible dividends.
Under the historical RDTOH rules, an eligible dividend paid by CCPC could allow for a refund of RDTOH. This provided an opportunity to corporations to pay eligible dividends and still recover RDTOH created from investment income, which did not accumulate to the CCPC’s GRIP from which the eligible dividend was paid. This allows for the shareholder to be subject to a lower personal tax rate in comparison to receiving a non-eligible dividend that would otherwise be paid from passive investment income earnings, and the corporation continues to enjoy a RDTOH refund.
Under the new rules introduced in the 2018 Federal Budget, the existing RDTOH account will be split into eligible RDTOH and non-eligible RDTOH pools. RDTOH created from passive income will accumulate to a CCPC’s non-eligible RDTOH account. This will be the case with most passive income apart from eligible dividends received from other entities. Only non-eligible dividends will result in a refund of non-eligible RDTOH balances. Further, ordering rules will also provide that amounts cannot generally be refunded from a CCPC’s eligible RDTOH account until the non-eligible RDTOH balance has been fully refunded. The character of RDTOH paid on dividends received from a connected corporation would match their payer’s eligible/ non-eligible RDTOH accounts. The significance is that now GRIP room is locked within a corporation and cannot be accessed until the entire non-eligible RDTOH pool is completely paid out.
For example, using a common corporate structure, Fred who is a successful business owner holds 100 per cent of his own holding company which also holds 100 percent of his operating company. Let us assume that the operating company has a GRIP balance of $10,000,000 and no RDTOH, while his holding company has an RDTOH balance of $2,000,000 and no GRIP. With the new rules as of January 1, 2019 the holding company will have its eligible RDTOH balance calculated as the lesser of the existing RDTOH balance as of January 1, 2019 or 38.33 percent of the GRIP balance (which is currently nil). Thus, the holding company’s entire RDTOH balance will be included in the non-eligible RDTOH pool and block any refund of RDTOH when GRIP dividends are paid from the operating company to the holding company and then to Fred. As a result, there is no transitional relief allowing for Fred to access his GRIP room which he is legally entitled to until he has paid out dividends from the holding company non-eligible RDTOH account to free up room.
The above rules will apply to taxation years beginning on or after January 1, 2019 and transitional measures have been included to compute the opening eligible RDTOH and non-eligible RDTOH balances of a CCPC. The eligible RDTOH balance will be calculated as the lesser of:
- The existing RDTOH balance at the time of the transition; and
- 33 percent of the GRIP balance, at the time of the transition
Once the above allocation has been calculated, any remaining RDTOH would be allocated to the non-eligible RDTOH pool.
While the above comments are indeed scary, a simple planning decision can be undertaken prior to the new regime coming into effect (before December 31, 2018). Using our previous example, prior to December 31, 2018 the operating company could pay an eligible safe income dividend to cause the GRIP balance in the holding company to equate to the RDTOH balance currently within the holding company. On transition, the eligible RDTOH balance of the holding company will now be calculated as the lesser of the existing RDTOH balance in the holding company and the GRIP balance now also in the holding company, which are both at the same amount. The resulting eligible RDTOH balance of the holding company will now equal at least the GRIP room, with no amounts added to the holding company’s non-eligible RDTOH pool. Accordingly, eligible dividends can continue to be paid from the operating company through the holding company to Fred, and still provide for a refund of the holding company’s RDTOH balances.
It would be recommended that taxpayers should examine their corporate structures prior to the rules coming into force on January 1, 2019 to determine potential planning opportunities.