# Investments inside corporation - 2018 Budget



## Synergy (Mar 18, 2013)

It looks as though the government is moving forward with some of the proposed changes to passive income earned inside a corporation.

"lower small business tax rate will be gradually reduced for corporations that earn more than $50,000 in an annual income from passive investments. Those earning $150,000 or more will not be eligible for the small business deduction."

Does anyone know if they are eliminating the RDTOH and / or the CDA accounts as well?

They claim that these changes will affect less than 3% of corporation. If they go ahead and remove the above notional accounts, they will be affecting closer to 100% of corporations.

Has anyone done the math for Ontario to see what the implications would be (interest vs dividends vs capital gains) - should the accounts be eliminated?

I'm also not 100% sure what they mean by "grandfathering". Does this mean that passive income earned on existing investments inside the corp will be subject to the old rules? How is one suppose to track this as the investment continues to grows each year!


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## tdiddy (Jan 7, 2015)

My interpretation is that they will not be eliminating RDTOH/CDA. Also, "grandfathering" has been taken off the table. 

Overall I am quite pleased with the new proposals, they are much fairer and easier to implement than previous.


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## heyjude (May 16, 2009)

Below is an extract of a news bulletin that I received today from my accounting firm (Crowe Mackay)

Refundability of Taxes on Investment Income
The current regime taxes a private corporation’s investment income at an upfront rate that approximates top individual tax brackets. This system is designed so that investment income earned by a corporation should be taxed approximately the same as investment income earned by an individual, both upfront and on a flow-through basis (also known as “integration”). This flow-through tax rate was designed based on the assumption that dividends are paid out of passive income and not active business income. However, private corporations can earn both passive income and “high-rate” active income, creating a cocktail of tax pools between refundable taxes (“RDTOH”) and general rate income (“GRIP”) that can benefit each other. Before applying the measures from this year’s Budget, a modest tax deferral could be gained where “GRIP” dividends were paid to recover ”RDTOH”. 

For tax years beginning after 2018, this deferral will no longer be available. Two RDTOH pools will exist, an eligible RDTOH pool and a non-eligible RDTOH pool. The proposed measures will effectively source the RDTOH to its underlying income and prevent [inappropriate] mixing to preserve tax integration. The refundable tax on investment income that is added to each pool is summarized as follows:









In the tax year that the rules take effect, a portion or all of the company’s opening RDTOH balance will be characterized as “Eligible RDTOH” in an amount equal to the lesser of the company’s RDTOH balance and 38.33% of its GRIP. This relieving provision appears to provide grandfathering.


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## Synergy (Mar 18, 2013)

Thanks for all the info. Is the above bulletin / chart stating that investors will no longer be able to recoup the previously refundable taxes on interest income and capital gains? 

Below is a good articles explaining the tax rates on investment inside a corp - 2017.

https://www.cibc.com/content/dam/sm.../pdfs/business_reports/in-good-company-en.pdf


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## heyjude (May 16, 2009)

Synergy said:


> Thanks for all the info. Is the above bulletin / chart stating that investors will no longer be able to recoup the previously refundable taxes on interest income and capital gains?


You can read it as well as I can.


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## Nerd Investor (Nov 3, 2015)

RDTOH and CDA aren't changing, the but they are eliminating the ability to get a dividend refund when you pay out eligible dividends _unless_ they arise from other eligible dividends received via an investment portfolio. 
Overall this isn't the total disaster I thought it would be.


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## OptsyEagle (Nov 29, 2009)

Nerd Investor said:


> RDTOH and CDA aren't changing, the but they are eliminating the ability to get a dividend refund when you pay out eligible dividends _unless_ they arise from other eligible dividends received via an investment portfolio.
> Overall this isn't the total disaster I thought it would be.


None of this means much to me, since I don't own a corporation, but I tend to like to understand things a little better. Who knows, maybe I can use it in the future.

Anyway. So we have a corporate owner, who earns money from both operating business and passive investments. Let's say they earned $1 from each. Now the $1 from the operating company gets a really nice tax rate via the small business deduction and the $1 from interest income, lets say, gets the daylights taxed out of it at a very high rate. Now this owner wants to pay themselves a dividend of $1. 

Now before these new rules, they would get a credit from the RDTOH account (how much I don't know) which was a tax refund to their corporation. That credit came about from rule governing the passive income that was earned. Had this person had no passive income then that credit would not be there. I believe I have that part right and that part I understand, assuming I do have it right.

Now with these new rules, it sounds like the government is saying, no, we think that dividend paid might be coming from your active income and we don't want to pay your corporation this refund via the RDTOH. I can understand that, but didn't that same government tax the daylights out of that interest income already. Why do they really care where it came from. Is that RDTOH credit not coming from the fact that they were probably overtaxing that passive income in the corporation already.

I suppose it did give a small advantage for the owner who wanted to have passive income in their corporation and also wanted to pay themselves some dividend income, over the owner that did not have passive income but also wanted to pay themselves a dividend. But again, this RDTOH credit arose from the high income tax rate on the passive income. At least that is what I thought.

I know I don't know enough about this stuff, but I am wondering where I am looking at this incorrectly. I also am not sure the difference between an eligible dividend and an ineligible dividend, at the moment, and perhaps that plays a part as well.

Could this stuff get anymore confusing?


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## heyjude (May 16, 2009)

Well, I’m certainly confused! I will wait till my accountant explains it to me in plain English and advises me what to do to minimize taxes. I suspect I will be emptying the RDTOH dividend account this year.


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## Synergy (Mar 18, 2013)

OptsyEagle - you are a brave soul!



> didn't that same government tax the daylights out of that interest income already





> Is that RDTOH credit not coming from the fact that they were probably overtaxing that passive income in the corporation already.


Yes, and the RDTOH was designed to improve tax integration. The goal was to ensure the same benefits from investing inside vs outside a corporation. Essentially, taxes payable on investment income in a corporation are taxed at the highest personal tax rate. Prior legislation did not however appear take into account the deferral advantage (investing with pre-tax corporate dollars). With that said, what is an RRSP for! I haven't crunched the numbers yet but it would appear that one would be better off taking larger salaries, maxing RRSP, etc. and leaving just enough in your corp / holdco in order to invest for growth, a rainy day, squeeze in under the new limits, etc.

I'm just taking a stab at it here but it would appear that Shareholders would see a 30% spike in taxes and the "perfect" integration lost. Perhaps this is how the gov is trying to eliminate the deferral advantage The business community doesn't seem all that upset so perhaps I'm missing something here.

Part 1 of their changes to Passive Income is simple, part 2 I need a few examples / charts in order to wrap my mind around it.


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## Synergy (Mar 18, 2013)

Actually, it's not as bad as I thought. The 2018 Budget supplement provides some clarity - page 17. 

https://www.budget.gc.ca/2018/docs/tm-mf/tax-measures-mesures-fiscales-2018-en.pdf


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## OptsyEagle (Nov 29, 2009)

Thanks Synergy. You were right. It takes a brave soul ,or perhaps too much time on ones hands, to read through and try to make heads or tails from all that stuff.

So it seems that what the Gov't was really trying to prevent was the tax deferral benefit of allowing a shareholder to invest passively in their corporation with retained earnings that were subjected to the small business deduction. That small business deduction was designed so that business owners could retain more money to reinvest in ACTIVE business operations. So when the owners decide to invest PASSIVELY, it goes against why they have this small business deduction in the first place.

OK. That I can understand. The problem is that I don't really see them doing that much to prevent it completely. They have certainly reduced the benefits of it but it would take a lot of math on my part to determine if it is still not better to invest passively inside the corporation as opposed to paying it out and investing it personally.

I guess it depends on each owner and corporation. By reducing the "Business Limit", which is the amount of money that gets the small business deduction, by how much passive income one has and/or how much assets the company has invested passively, I suppose that may reduce the incentive to build up those passive assets. However, for someone who has almost no active income now and only passive income left, I don't see this changing much for them. 

I have not gone through a calculation from the changes to the RDTOH accounts, and perhaps that is where the Gov't hopes to address those cases, but all in all, it just seems like an overly complicated way to get at the issue that there is an advantage to a business owner to invest inside their corporation with capital that has some deferred taxation attached to it, when regular non-corporation owning taxpayers do not have. I would write that off to a reward for simply taking on the risks that the non-corporation owning taxpayer does not bear.

I think they should have spent more time on who should be allowed to incorporate and then when they were done, leave things the way they were. But, they never asked me my opinion. Thanks for your help. I am still confused, but a little less now.


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## Synergy (Mar 18, 2013)

OptsyEagle said:


> it just seems like an overly complicated way to get at the issue that there is an advantage to a business owner to invest inside their corporation with capital that has some deferred taxation attached to it, when regular non-corporation owning taxpayers do not have. I would write that off to a reward for simply taking on the risks that the non-corporation owning taxpayer does not bear.


I'd have to agree here - overly complicated. Business owners are feeling like they are being attacked and punished. We need some regulation to keep things reasonable but I don't see why business owners can't reap some additional benefits here. Everyone is free to start their own business, register a corporation, create jobs, support the local economy, etc. Anyhow, when I get the chance I'll try to post some numbers to try and make sense of the changes pre and post budget.


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## tdiddy (Jan 7, 2015)

Here's my take on part 2 of this change with an example: 

I have a 30K capital gain to crystallize as i switch from XEF to HXDM. I was waiting for these changes to be announced before doing anything. The RDTOH and CDA will be funded by the taxes I pay on this sale. Say I pay a dividend that clears the CDA/RDTOH. If my CCPC was netting >500K, my dividend rate would be taxed personally at eligible dividend rate. Under the new rules, in order to empty RDTOH dividend would be inelgible and I would pay a higher personal tax on it. If however, i had a 5K public dividend from VCN, that would be an exception and I could clear RDTOH and pay personal tax at eligible rate on dividend I pay out. 

I will be running this by my accountant, happy to be corrected


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## Synergy (Mar 18, 2013)

tdiddy said:


> I will be running this by my accountant, happy to be corrected


Let us know what your accountant says.

Your logic seems correct to me. It appears that the Budget is eliminating this mismatch. From what I've read this was somewhat of a tax loophole and not that many corporation where likely taking advantage of. So they say. For some reason I believe I've always paid the non-eligible rate on investment income - other than the eligible portfolio dividends which where withdrawn / paid as eligible. Once the tax rush is over I'm meaning to fire off a few questions to my accountant.

I'm still wondering whether or not the refundable portion / percentages will be changing.


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## Nerd Investor (Nov 3, 2015)

tdiddy said:


> Here's my take on part 2 of this change with an example:
> 
> I have a 30K capital gain to crystallize as i switch from XEF to HXDM. I was waiting for these changes to be announced before doing anything. The RDTOH and CDA will be funded by the taxes I pay on this sale. Say I pay a dividend that clears the CDA/RDTOH. If my CCPC was netting >500K, my dividend rate would be taxed personally at eligible dividend rate. Under the new rules, in order to empty RDTOH dividend would be inelgible and I would pay a higher personal tax on it. If however, i had a 5K public dividend from VCN, that would be an exception and I could clear RDTOH and pay personal tax at eligible rate on dividend I pay out.
> 
> I will be running this by my accountant, happy to be corrected


You've got it! The RDTOH mechanism is basically unchanged except in the instance one has a GRIP balance which allows them to pay out eligible dividends.


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## FrugalTrader (Oct 13, 2008)

Nerd Investor said:


> You've got it! The RDTOH mechanism is basically unchanged except in the instance one has a GRIP balance which allows them to pay out eligible dividends.


Can anyone clarify the "order" rule? I have a Canadian (eligible) dividend portfolio within my corp, and I'm reading that non-eligible RDTOH needs to be cleared out before eliglbe RDTOH can be accessed?


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## Synergy (Mar 18, 2013)

FrugalTrader said:


> Can anyone clarify the "order" rule? I have a Canadian (eligible) dividend portfolio within my corp, and I'm reading that non-eligible RDTOH needs to be cleared out before eliglbe RDTOH can be accessed?


From what I understand, when a CCPC issues a non-eligible dividend it will be required to recover non-eligible RDTOH before eligible RDTOH, unless it issues an eligible dividend. Portfolio dividends are the exception to the rule, as stated in the above example.


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## Synergy (Mar 18, 2013)

Nerd Investor said:


> You've got it! The RDTOH mechanism is basically unchanged except in the instance one has a GRIP balance which allows them to pay out eligible dividends.


Are the calculations and refundable amounts the same for the new NRDTOH account? 30.67% of investment income and 33% of portfolio dividends are added and refundable at a rate of 33%?


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## Nerd Investor (Nov 3, 2015)

Synergy said:


> Are the calculations and refundable amounts the same for the new NRDTOH account? 30.67% of investment income and 33% of portfolio dividends are added and refundable at a rate of 33%?


It's 38.33% of portfolio dividends now (which is also the rate at which a dividend refund is received when dividends are paid out). But that changed previously and independently of these corporate tax changes, nothing to do with the budget.


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## Synergy (Mar 18, 2013)

Nerd Investor said:


> It's 38.33% of portfolio dividends now (which is also the rate at which a dividend refund is received when dividends are paid out). But that changed previously and independently of these corporate tax changes, nothing to do with the budget.


Great, thanks. 38.33% of portfolio dividends and 30.67% of investment income, refunded at 38.33%. No changes with the new budget. Now I can crunch some numbers.


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