Notice of Ways and Means Motion April 2018: Passive Income, RDTOH, and Small Business Deduction Grind

Passive Investment Income

 

Budget 2018

Active business income earned by private corporations is taxed at corporate income tax rates that are generally lower than personal income tax rates, giving these corporations more money to invest in order to grow their business. In addition, a small Canadian-controlled private corporation (CCPC) can benefit from a corporate income tax rate on qualifying active business income that is lower than the general corporate income tax rate. The intention of the lower small business tax rate is to leave small CCPCs, which may have difficulty accessing capital, with more retained earnings to reinvest in their active businesses.

Business income retained in a corporation, however, can also be used to finance passive investments. The current tax regime relating to passive investment income earned by private corporations has been in place since 1972. In contrast to active business income (which includes investment income that is incidental to an active business), additional taxes apply to passive investment income in the year in which it is earned. These additional taxes are intended to ensure that taxes payable by private corporations on investment income approximate top federal-provincial-territorial personal income tax rates. A portion of the tax on investment income is refundable to a corporation upon the payment of taxable dividends, and the income is then subject to progressive personal income tax rates in the hands of its individual shareholders.

Where funds invested passively within a private corporation have been financed with retained earnings that have been taxed at preferential corporate income tax rates, owners of the corporation can benefit from a tax deferral advantage relative to a situation where the corporation distributes the retained earnings and the owners invest personally in passive investments. This issue was the subject of public consultations that were launched in July 2017.

Budget 2018 proposes two measures, applicable to taxation years that begin after 2018, to limit tax deferral advantages on passive investment income earned inside private corporations. These measures take into account the feedback received from stakeholders in response to the July 2017 consultation.

1 Measure # 1: Business Limit

The Government has proposed to reduce the tax rate for qualifying active business income of small CCPCs from 10.5 per cent to 10 per cent for 2018 and to 9 per cent as of 2019. This lower rate – relative to the 15-per-cent general corporate rate – is intended to increase the after-tax income available for reinvestment in the active business, in recognition that small businesses tend to have more difficulty accessing capital. This rate reduction is provided through the small business deduction.

This preferential tax rate applies on up to $500,000 of qualifying active business income of a CCPC (the “business limit”). There is a requirement to allocate the business limit among associated corporations. The business limit is reduced on a straight-line basis for a CCPC and its associated corporations having between $10 million and $15 million of total taxable capital employed in Canada.

When retained earnings taxed at the small business rate are used to invest passively, rather than in the active business, significant tax deferral advantages can be realized relative to an individual investor.

Budget 2018 proposes to reduce the business limit for CCPCs (and their associated corporations) that have significant income from passive investments.

1.1 Business Limit Reduction

Under this measure, the business limit will be reduced on a straight-line basis for CCPCs having between $50,000 and $150,000 in investment income.

The measure will affect CCPCs only to the extent that their business income exceeds the reduced business limit (Table 2).

For example, a CCPC with $100,000 of investment income would have its business limit reduced to $250,000.

As long as the reduced business limit remains above the active business income of the CCPC, all of that income would continue to be taxed at the small business tax rate. A CCPC with $75,000 of business income would have to earn more than $135,000 in passive income before its business limit is reduced below its business income. This feature of the proposed rules recognizes that CCPCs with lower amounts of business income generate less retained earnings that can later be used for reinvestment in the business, and may have more difficulty accessing capital. CCPCs with business income above the reduced business limit will be taxed on income above the business limit at the general corporate tax rate.

Table 2
Active business income qualifying for the small business tax rate under new business limit ($)
Business IncomeInvestment Income
50,00075,000100,000125,000150,000
50,0000
75,000NOT AFFECTED0
100,0000
200,000125,0000
300,000250,000125,0000
400,000375,000250,000125,0000
500,000375,000250,000125,0000
Note: Assumes that the corporation has less than $10 million of taxable capital.

The measure will be implemented based on a CCPC’s investment income, which is earned on the underlying passive investment assets held by the corporation. Assuming a five-per-cent return on such investments, the business limit would effectively be reduced on a straight-line basis for CCPCs having between $1 million and $3 million of passive assets. Assuming a two-per-cent return in low-risk investments, the business limit would be reduced between $2.5 million and $7.5 million of passive assets. For illustrative purposes, Table 3 shows the effect of the measure on qualifying active business income for a given level of passive assets and an assumed rate of return. For instance, a CCPC with $3.75 million in passive assets invested at a two-per-cent rate of return would continue to benefit from the small business tax rate on up to $375,000 of business income.

Table 3
Active business income qualifying for the small business tax rate under new business limit for illustrative passive assets ($)
Business IncomePassive Assets
1,000,000(*)/ 2,500,000(**)1,500,000(*)/ 3,750,000(**)2,000,000(*)/ 5,000,000(**)2,500,000(*)/ 6,250,000(**)3,000,000(*)/ 7,500,000(**)
50,0000
75,000NOT AFFECTED0
100,0000
200,000125,0000
300,000250,000125,0000
400,000375,000250,000125,0000
500,000375,000250,000125,0000
Note: Assumes that the corporation has less than $10 million of taxable capital. (*) Assuming a five-per-cent rate of return. (**) Assuming a two-per-cent rate of return.

It is expected that about three per cent of CCPCs claiming the small business deduction will be affected by the measure.

The business limit reduction under this measure will operate alongside the business limit reduction that applies in respect of taxable capital in excess of $10 million. The reduction in a corporation’s business limit will be the greater of the reduction under this measure and the existing reduction based on taxable capital.

The reduction of the business limit for any particular corporation under this measure will be based on the investment income of the corporation and, consistent with the reduction in the business limit based on taxable capital, any other associated corporations with which it is required to share the business limit for a taxation year.

1.2 Business Limit – Adjusted Aggregate Investment Income and Exemptions for Active Business Assets and Small Business Corporation Shares

For the purpose of determining the reduction of the business limit of a CCPC, investment income will be measured by a new concept of “adjusted aggregate investment income” which will be based on “aggregate investment income” (a concept that is currently used in computing the amount of refundable taxes in respect of a CCPC’s investment income) with certain adjustments. The adjustments will include the following:

  • taxable capital gains (and losses) will be excluded to the extent they arise from the disposition of
    • a property that is used principally in an active business carried on primarily in Canada by the CCPC or by a related CCPC; or
    • a share of another CCPC that is connected with the CCPC, where, in general terms, all or substantially all of the fair market value of the assets of the other CCPC is attributable directly or indirectly to assets that are used principally in an active business carried on primarily in Canada, and certain other conditions are met;
  • net capital losses carried over from other taxation years will be excluded;
  • dividends from non-connected corporations will be added; and
  • income from savings in a life insurance policy that is not an exempt policy will be added, to the extent it is not otherwise included in aggregate investment income.

Consistent with existing rules relating to aggregate investment income, adjusted aggregate investment income will not include income that is incidental to an active business.

1.3 Application

This measure will apply to taxation years that begin after 2018.

Rules will apply to prevent transactions designed to avoid the measure, such as the creation of a short taxation year in order to defer its application and the transfer of assets by a corporation to a related corporation that is not associated with it.

2 Measure #2: Refundability of Taxes on Investment Income

The current tax regime relating to refundable taxes on investment income of private corporations seeks to tax income from passive investments at approximately the top personal income tax rate while that income is retained in the corporation. Some or all of these taxes are added to the corporation’s refundable dividend tax on hand (RDTOH) account and are refundable at a rate of $38.33 for every $100 of taxable dividends paid to shareholders.

For income tax purposes, dividends paid by corporations are either “eligible” or “non-eligible”:

  • Non-eligible dividends are presumed to have been paid from a corporation’s active business income that has been subject to the small business tax rate (including non-eligible dividends received by the corporation) or from passive investment income, but excluding the
    non-taxable portion of capital gains as well as eligible portfolio dividends (i.e., dividends that are paid by non-connected corporations as eligible dividends). An individual who receives non-eligible dividends is entitled to the ordinary dividend tax credit which, at the federal level, the Government has proposed be 10 per cent in 2018, and 9 per cent after 2018.
  • Eligible dividends are presumed to have been paid from a corporation’s active business income that has been subject to the general corporate income tax rate (including eligible dividends received by the corporation). An individual who receives eligible dividends is entitled to the enhanced dividend tax credit which, at the federal level, is 15 per cent.

Generally, investment income earned by private corporations must be paid as non-eligible dividends (exceptions include eligible portfolio dividends, which may be paid as eligible dividends, and the non-taxable portion of capital gains, which may be paid as tax-free capital dividends). A corporation, however, may obtain a refund of taxes paid on investment income, reflected in the corporation’s RDTOH account, regardless of whether the dividends paid are eligible or non-eligible.

As a result, the current system allows a corporation to receive an RDTOH refund upon the payment of an eligible dividend (which entitles an individual receiving the dividend to the enhanced dividend tax credit) in situations where the corporation’s RDTOH was generated from investment income that would need to be paid as a non-eligible dividend. This can provide a tax deferral advantage on passive investment income by allowing private corporations paying eligible dividends sourced from active business income taxed at the general corporate income tax rate to generate a refund of taxes paid on passive income.

To better align the refund of taxes paid on passive income with the payment of dividends sourced from passive income, Budget 2018 proposes that a refund of RDTOH be available only in 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 refund of that RDTOH upon the payment of eligible dividends.

The different treatment proposed regarding the refund of taxes imposed on eligible portfolio dividend income will necessitate the addition of a new RDTOH account.

  • This new account (eligible RDTOH) will track refundable taxes paid under Part IV of the Income Tax Act on eligible portfolio dividends. Any taxable dividend (i.e., eligible or non-eligible) will entitle the corporation to a refund from its eligible RDTOH account (subject to the ordering rule described below).
  • The current RDTOH account (which will now be referred to as non-eligible RDTOH) will track refundable taxes paid under Part I of the Income Tax Act on investment income as well as under Part IV on non-eligible portfolio dividends (i.e., dividends that are paid by non-connected corporations as non-eligible dividends). Refunds from this account will be obtained only upon the payment of non-eligible dividends.
2.1 RDTOH Recapture – Connected Corporations

Currently, if a corporation obtains a refund of RDTOH upon the payment of a dividend to a connected corporation, the recipient corporation pays refundable tax under Part IV of the Income Tax Act equal to the amount of tax refunded to the payor. This amount is then added to the recipient corporation’s RDTOH account. Under this measure, the corporation receiving such a dividend will continue to pay an amount of Part IV tax equal to the refund obtained by the payor corporation. This amount, however, will be added to the RDTOH account of the recipient corporation that matches the RDTOH account from which the payor corporation obtained its refund.

2.2 RDTOH Refunds – Ordering Rule

Upon the payment of a non-eligible dividend, a private corporation will be required to obtain a refund from its non-eligible RDTOH account before it obtains a refund from its eligible RDTOH account.

2.3 Application

This measure will apply to taxation years that begin after 2018.

An anti-avoidance rule will apply to prevent the deferral of the application of this measure through the creation of a short taxation year.

A corporation’s existing RDTOH balance will be allocated as follows:

  • For a CCPC, the lesser of its existing RDTOH balance and an amount equal to 38⅓ per cent of the balance of its general rate income pool, if any, will be allocated to its eligible RDTOH account. Any remaining balance will be allocated to its non-eligible RDTOH account.
  • For any other corporation, all of the corporation’s existing RDTOH balance will be allocated to its eligible RDTOH account

3 Legislation – Refundability of Taxes on Investment Income

3.1 Business limit reduction – passive investment income

ITA 125(5.1)

In broad terms, under subsection 125(5.1) of the Act, the business limit of a corporation for a particular taxation year is reduced on a straight-line basis if the total of the taxable capital of the corporation and, if applicable, of other corporations with which the corporation is associated (referred to as its “associated corporations”) exceeds $10 million. A corporation’s entitlement to the small business deduction for a particular taxation year is determined by reference, among other things, to the business limit of the corporation for the particular taxation year that is otherwise determined under subsections 125(2) to (5).

Subsection 125(5.1) is amended to provide an additional restriction to a corporation’s business limit based on the passive investment income of the corporation and its associated corporations. The corporation’s business limit will now be reduced by the greater of the reduction provided under the existing rule (the “taxable capital reduction”), now contained in paragraph 125(5.1)(a), and the new “passive income reduction”, contained in paragraph 125(5.1)(b).

The passive income reduction reduces a corporation’s business limit for a taxation year (as otherwise determined) by five dollars for every dollar by which the corporation’s “adjusted aggregate investment income” (as newly defined in subsection 125(7)), and that of its associated corporations, for taxation years ending in the preceding calendar year exceeds $50,000.  

Example 1

ACo has a July 1 to June 30 taxation year.  It is not associated with any other corporation in its taxation year ending June 30, 2021 nor in its previous taxation year. For the taxation year ending June 30, 2020, it has taxable capital employed in Canada of $14 million and adjusted aggregate investment income of $100,000. Its business limit, determined without reference to subsection 125(5.1) is $500,000 for its taxation year ending June 30, 2021.

For its taxation year ending June 30, 2021:

  • ACo’s taxable capital reduction under paragraph 125(5.1)(a) is $500,000 x (0.225% x ($14,000,000 – $10,000,000)) / $11,250 = $400,000; and
  • ACo’s passive income reduction under paragraph 125(5.1)(b) is $500,000/$500,000 x 5 × ($100,000 – $50,000) = $250,000.

Therefore, the reduction to ACo’s business limit is $400,000, which is the greater of the taxable capital and passive income reductions, leaving it with a business limit of $100,000 for its taxation year ending June 30, 2021.

Example 2

  • ACo has a July 1 to June 30 taxation year and BCo has a January 1 to December 31 taxation year.
  • ACo and BCo are associated throughout the period from January 1, 2021 to December 31, 2021.
  • At all relevant times, the taxable capital employed in Canada of ACo and BCo totals less than $10 million.
  • For its taxation year ending June 30, 2020, ACo has adjusted aggregate investment income of $80,000.
  • For its taxation year ending December 31, 2020, BCo has adjusted aggregate investment income of $60,000. ACo and BCo are each assigned $250,000 of the $500,000 business limit for all relevant taxation years.

ACo’s business limit for its taxation year ending June 30, 2021 will be reduced under subsection 125(5.1) by $250,000/$500,000 × 5 × ($140,000 – $50,000) = $225,000, leaving it with an adjusted business limit of $25,000.

BCo’s business limit for its taxation year ending December 31, 2021 will also be reduced by $225,000, leaving it with an adjusted business limit of $25,000.

3.2 Anti-avoidance

ITA 125(5.2)

New subsection 125(5.2) is an anti-avoidance rule intended to prevent the avoidance of the application of the “passive income reduction” rule in paragraph 125(5.1)(b) through the transfer of property to a related company. The rule operates to deem two corporations to be associated with each other where they are not otherwise associated. It applies where the corporations are related to each other, one corporation (directly or indirectly) transfers assets to the other corporation and one of the reasons for the transfer can reasonably be considered to be to reduce the amount of the “adjusted aggregate investment income” of the associated group for the purposes of the “passive income reduction” rule in paragraph 125(5.1)(b).

3.5 Definitions

ITA 125(7)

Subsection 125(7) contains definitions for the purposes of the small business deduction rules in section 125. Subsection 125(7) is amended by adding the new definitions “active asset” and “adjusted aggregate investment income”, which are relevant for the new passive income business limit reduction rule in paragraph 125(5.1)(b).

Active asset

The definition “active asset” is relevant exclusively for the new definition “adjusted aggregate investment income”. Any taxable capital gains or allowable capital losses in a taxation year from the disposition of an “active asset” will not be included in the computation of a corporation’s “adjusted aggregate investment income” and will, as such, have no impact on a corporation’s passive income business limit reduction under paragraph 125(5.1)(b).

An active asset of a particular corporation, at any time, is any of the following three types of property:

  1. Property used at that time principally in an active business carried on primarily in Canada by the particular corporation (which could include a business carried on by it as a member of a partnership) or by a Canadian-controlled private corporation that is related to the particular corporation;
  2. A share of the capital stock of another corporation if, at that time,
    • the other corporation is connected with the particular corporation (within the meaning assigned by subsection 186(4) on the assumption that the other corporation is at that time a “payer corporation” within the meaning of that subsection), and
    • the share would be a “qualified small business corporation share” (as defined in subsection 110.6(1)) if
      • the references in that definition to an “individual” were references to the particular corporation, and
      • that definition were read without reference to “the individual’s spouse or common law partner”; or
  3. An interest in a partnership, if
    • at that time, the fair market value of the particular corporation’s interest in the partnership is equal to or greater than 10% of the total fair market value of all interests in the partnership,
    • throughout the 24–month period ending before that time, more than 50% of the fair market value of the property of the partnership was attributable to any of these three types of property, and
    • at that time, all or substantially all of the fair market value of the property of the partnership was attributable to any of these three types of property.

Adjusted aggregate investment income

The “adjusted aggregate investment income” of a corporation for a taxation year is used in determining the “passive income reduction” of the corporation (and, if applicable, its associated corporations) under new paragraph 125(5.1)(b).

Adjusted aggregate investment income is a modified version of the existing “aggregate investment income” definition in subsection 129(4) and is generally relevant for the determination of a Canadian-controlled private corporation’s refundable taxes on investment income.

More particularly, a corporation’s “adjusted aggregate investment income” for a taxation year is the amount of the corporation’s “aggregate investment income”, with the following adjustments:

  • Capital gains and losses from the disposition of active assets are not taken into account.
  • The corporation cannot deduct any net capital losses from other taxation years.
  • Dividends from other corporations can only be excluded to the extent they are received from connected corporations.
  • All income from a “specified investment business” is included.
  • Amounts in respect of a life insurance policy that are included in computing the corporation’s income for the year are added (to the extent that the amounts would not otherwise be included in the computation of the corporation’s “aggregate investment income”).
  • No amount can be deducted under subsection 91(4) in computing the corporation’s income. Subsection 91(4) otherwise provides for a deduction from income for the taxes paid in respect of the “foreign accrual property income” of a foreign affiliate of the corporation.

The new definition “adjusted aggregate investment income” does not apply to a cooperative corporation to which subsection 136(1) applies, a credit union to which subsection 137(7) applies or to an insurance corporation to which section 141.1 applies. As such, the “passive income reduction” rule in paragraph 125(5.1)(b) does not apply to such corporations.

3.6 Coming-into-force

The amendments to subsections 125(5.1) and (7) and the addition of new subsection 125(5.2) apply to taxation years that begin after 2018. However, these amendments – along with the amendments to paragraph 87(2)(aa), sections 129 and 131 and subsection 186(5) – also apply to a taxation year of a corporation that begins before 2019 and ends after 2018 in circumstances where the corporation uses a short taxation year in order to defer the application of the amendments to section 125 or 129.

4 Legislation – Refundability of Taxes on Investment Income

 

4.1 Dividend refund to private corporation

ITA 129

Section 129 of the Act provides the mechanism under which a portion of the taxes paid by a private corporation in respect of its investment income (tracked in its “refundable dividend tax on hand” or “RDTOH” account) is refundable to the corporation when taxable dividends are paid to its shareholders. The RDTOH account contains two primary components: amounts in respect of Part I taxes paid on investment income by a Canadian-controlled private corporation and amounts in respect of Part IV taxes paid on dividends received by a private corporation.

The current system allows RDTOH to be refunded upon the payment of any type of taxable dividend, whether it be an “eligible dividend” (as defined in subsection 89(1)) or otherwise (in these notes, a taxable dividend that is not an eligible dividend is referred to as a “non-eligible dividend”). The distinction between eligible and non-eligible dividends is primarily relevant for determining the quantum of the “dividend tax credit” under section 121 that may be obtained by an individual upon the receipt of dividends from a corporation resident in Canada.

In general terms, section 129 is amended to split the existing RDTOH account into two separate accounts, referred to as “eligible refundable dividend tax on hand” (ERDTOH) and “non-eligible refundable dividend tax on hand” (NERDTOH), and to provide that dividend refunds under subsection 129(1) may only be obtained from NERDTOH to the extent the taxable dividends paid by the corporation are non-eligible dividends.

4.2 Dividend refund

ITA 129(1)

Subsection 129(1) defines the term “dividend refund” for the purposes of the Act and provides the specific computational and administrative rules for the issuance by the Minister of National Revenue of such dividend refunds.

Subsection 129(1) is amended to provide for the new limitation in respect of dividend refunds relating to eligible dividends and to take into account the replacement of the RDTOH account with the new ERDTOH and NERDTOH accounts, both as defined in subsection 129(4). Mechanically, a corporation’s dividend refund for a taxation year is now the total of the amount determined under subparagraph 129(1)(a)(i) and clause 129(1)(a)(ii)(B) (in respect of ERDTOH) and the amount determined under clause 129(1)(a)(ii)(A) (in respect of NERDTOH), for the year.

Pursuant to amended subparagraph 129(1)(a)(i), an eligible dividend paid by a corporation in a taxation year can only give rise to a dividend refund for that year in respect of its ERDTOH – no dividend refund can be obtained in respect of its NERDTOH. Such dividend refund is equal to the lesser of 38 1/3% of all eligible dividends paid by the corporation in the year and the corporation’s ERDTOH at the end of the year.

Pursuant to amended subparagraph 129(1)(a)(ii), when a corporation pays a non-eligible dividend in a taxation year it can receive a dividend refund for that year in respect of its NERDTOH or its ERDTOH. However, no dividend refund in respect of a non-eligible dividend can be paid from the corporation’s ERDTOH while any amount remains in the corporation’s NERDTOH. In other words, inherent in paragraph 129(1)(a) is an ordering rule whereby non-eligible dividends must first reduce NERDTOH before being allowed to reduce ERDTOH.

More specifically, clause 129(1)(a)(ii)(A) includes in a corporation’s dividend refund for a taxation year an amount equal to the lesser of 38 1/3% of all non-eligible dividends paid by it in the year and the corporation’s NERDTOH at the end of the year. If the total amount of the corporation’s non-eligible dividends paid in a taxation year exceeds the amount required to fully refund its NERDTOH, clause 129(1)(a)(ii)(B) provides an additional amount of dividend refund, in respect of ERDTOH.

Example 1

At the end of its 2021 taxation year, ACo has $100 in its ERDTOH and $300 in its NERDTOH. During that year, ACo paid a $1,000 eligible dividend and no non-eligible dividends.

ACo’s total dividend refund for the year will be $100, all from its ERDTOH, based on the lesser of $1,000 x 38 1/3% = $383.33 and $100 (the year-end balance of its ERDTOH). The dividend being an eligible dividend, ACo cannot receive a dividend refund in respect of its NERDTOH.

Example 2

At the end of its 2024 taxation year, BCo has $200 in its ERDTOH and $300 in its NERDTOH. During that year, BCo pays a $1,000 non-eligible dividend and no eligible dividends.

BCo’s total dividend refund for the year will be $383.33 and it will have $116.67 of ERDTOH to carry forward to its 2025 taxation year but no amount of NERDTOH to carry forward. These amounts are determined as follows:

  1. Under clause 129(1)(a)(ii)(A), BCo will be entitled to receive a $300 dividend refund from its NERDTOH, based on the lesser of $1,000 x 38 1/3% = $383.33 and $300 (the year-end balance of its NERDTOH).
  2. The dividend being a non-eligible dividend, BCo can also receive a dividend refund from its ERDTOH, as there is an excess amount. More specifically, subclause 129(1)(a)(ii)(B)(I) will add an amount to BCo’s dividend refund based on the lesser of the “excess amount” of $383.33 – $300 = $83.33 and $200 (the year-end balance of its ERDTOH).

4.3 Dividends paid to bankrupt controlling corporation

ITA 129(1.1)

Subsection 129(1.1) denies a dividend refund to a corporation in respect of taxable dividends paid to a bankrupt controlling corporation.

Subsection 129(1.1) is amended to make consequential changes to take into account the amendments to paragraph 129(1)(a).

4.4 Refundable dividend tax on hand

ITA 129(3)

Currently, a corporation’s dividend refund for a taxation year under subsection 129(1) is determined by reference to the corporation’s “refundable dividend tax on hand” (RDTOH), as set out in subsection 129(3). Subsection 129(3) is being repealed and is effectively replaced with the new definitions “eligible refundable dividend tax on hand” and “non-eligible refundable dividend tax on hand”, which are both defined in subsection 129(4).

4.5 Definitions

ITA 129(4)

Two new definitions are being added to subsection 129(4), “eligible refundable dividend tax on hand” (ERDTOH) and “non-eligible refundable dividend tax on hand” (NERDTOH). These definitions are relevant for the determination of a corporation’s dividend refund under subsection 129(1) and replace the term “refundable dividend tax on hand” (RDTOH) in subsection 129(3), which is being repealed.

ERDTOH

ERDTOH tracks a corporation’s tax paid under Part IV in respect of:

  • eligible dividends received from non-connected corporations; and
  • taxable dividends received from connected corporations to the extent that that such dividends cause the payer corporation to receive a dividend refund from its ERDTOH.

For these purposes, the “connected” status of corporations is determined using the rules in section 186.

A corporation’s ERDTOH will be reduced by dividend refunds for a preceding taxation year in respect of its ERDTOH, as provided for in subparagraph 129(1)(a)(i) (in respect of eligible dividends) and clause 129(1)(a)(ii)(B) (in respect of non-eligible dividends). For additional information on the new dividend refund mechanism, see the comments under subsection 129(1).

NERDTOH

NERDTOH tracks:

  • the refundable Part I tax in respect of the investment income of a Canadian-controlled private corporation; and
  • the Part IV tax paid by a corporation in respect of dividends other than those described under ERDTOH.

Subparagraphs (a)(i) to (iii) of the NERDTOH definition correspond directly to subparagraphs 129(3)(a)(i) to (iii) of the definition RDTOH in subsection 129(3), which is being repealed.

A corporation’s NERDTOH will be reduced by dividend refunds for a preceding taxation year in respect of its NERDTOH. Such dividend refunds can only arise upon the payment by the corporation of non-eligible dividends. For additional information on the new dividend refund mechanism, see the comments under subsection 129(1).

4.6 2019 transitional RDTOH

ITA 129(5)

New subsection 129(5) provides rules to transition a corporation’s existing RDTOH into the new ERDTOH and NERDTOH regime. If a corporation is a Canadian-controlled private corporation in its first taxation year under the new regime and its preceding taxation year, and it does not have an election under subsection 89(11) in effect for either of those years, the net RDTOH balance of such a corporation for its preceding taxation year (i.e., RDTOH net of its dividend refund for that year) is allocated to its first year’s ERDTOH to the extent of 38 1/3% of its net “general rate income pool” (GRIP) balance for the preceding year (i.e., GRIP net of eligible dividends paid in that year) and the remainder is allocated to its first year’s NERDTOH. The net RDTOH balance of any other corporation is allocated entirely to its first year’s ERDTOH.

4.7 2019 transitional RDTOH – amalgamations

ITA 129(5.1)

New subsection 129(5.1) is intended to integrate subsection 129(5) and paragraph 87(2)(aa) in respect of amalgamations in which one or more predecessor corporations has an RDTOH balance and the new corporation is subject to the new ERDTOH and NERDTOH regime. This rule is meant to ensure that the transitional rule in subsection 129(5) applies to each such predecessor corporation before the balances of ERDTOH and NERDTOH are combined under paragraph 87(2)(aa) in respect of the new corporation.

4.8 Coming-into-force

All of the amendments to section 129 apply to taxation years that begin after 2018, subject to the possible application of an anti-avoidance rule. See the comments under section 125 for more information.

 

Source: 

Budget 2018
Notice of Ways and Means Motion  February 27, 2018 
Explanatory Notes Relating to the Income Tax Act and to Other Legislation

 

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