Limited time to recover refundable tax

If your clients have incorporated businesses, talk to them about a recent Federal Court of Appeal decision that reminds business owners how important it is to file their corporate returns on time.

Background

“Keep it in the corporation.” That’s what we often suggest clients owning small businesses do with money they don’t need for current lifestyle spending. The preferential tax treatment of active business income results in a substantial tax deferral. Only when those funds are later withdrawn will they be subject to personal tax rates.

When investment income and capital gains are earned inside a Canadian-controlled private corporation, the CCPC must pay federal refundable tax of 26 2/3% and include that balance in the corporation’s notional Refundable Dividend Tax on Hand (RDTOH) account (for more on this, see advisor.ca/RDTOH). When taxable dividends are paid out to shareholders, a dividend refund equal to 33.33% of the dividends paid (up to the balance in the RDTOH account) is refunded to the corporation.

The purpose of this rule is to ensure corporations initially pay about 50% total federal and provincial tax on investment income. This eliminates the incentive to earn investment income in a corporation rather than personally, where the top marginal rate is also about 50%, depending on the client’s province of residence.

Once sufficient dividends are paid out, the dividend refund mechanism, combined with the gross-up and dividend tax credit system, ensure the total tax paid on investment income earned through a corporation and paid out as a dividend is roughly equal to the tax payable had the individual earned that investment income personally.

For a corporation to get its dividend refund for a particular tax year, it must file that year’s tax return within three years. If it misses that three-year deadline, there seems to be no solution, as an Ontario company recently found out.

Consequences of missing the deadline

The case, 1057513 Ontario Inc. v The Queen (2015 FCA 207), involved a corporation, 1057513 Ontario Inc., that found itself in the Federal Court of Appeal this past fall appealing a decision of the Tax Court of Canada.

The Tax Court had dismissed the taxpayer’s appeal of reassessments for tax years 1997 through 2004.

During those years, the taxpayer paid refundable tax. The company also paid sufficient dividends that, if its corporate tax returns had been filed within the three-year period set out under the Income Tax Act, would have resulted in a dividend refund for each year. But, since the corporation did not file its tax returns for the years in question until 2008, it was ineligible to receive the dividend refunds.

The issue before the appellate court was whether the Tax Court had committed any error in concluding that there is a requirement to file tax returns within three years from the end of the taxation year in which the dividend is paid in order to receive the dividend refund.

The Federal Court of Appeal could see no reason to overturn the Tax Court’s finding and dismissed the taxpayer’s appeal, denying the dividend refunds.

This harsh result echoes a statement made by CRA in 2011 concerning the rule. CRA had stated, “We cannot envision a situation in which an action […] would enable a taxpayer to obtain a dividend refund beyond the period described.”

If you have corporate clients who earn investment income, this case serves as a reminder that missing tax deadlines can have severe consequences.

How to calculate RDTOH

The corporation’s tax return is used to track its Refundable Dividend Tax on Hand (RDTOH) account activity.

The account’s opening balance is the prior year’s closing balance, less any dividend refund paid the prior year. The next step is to add 26.67% of Aggregate Investment Income (interest, rent, royalties, income from property and net taxable capital gains, less business investment losses and related expenses) and 33% of portfolio dividends to determine the RDTOH balance at the end of the year. The dividend refund from the RDTOH is calculated as the lesser of 33% of taxable dividends paid and the RDTOH balance at the end of the year.

– James and Deborah Kraft

Jamie Golombek

Tax & Estate

Managing Director, Tax and Estate Planning, CIBC Private Wealth Team Jamie Golombek is Managing Director, Tax and Estate Planning with CIBC in Toronto. As a member of the CIBC Private Wealth team, Jamie works closely with advisors from across CIBC to support their clients and deliver integrated financial planning and strong advisory solutions. He joined the firm in 2008 after 12 years with a global investment company, where he was involved in both internal and external consulting on all areas of taxation and estate planning. Jamie has also worked for Deloitte as a tax specialist in the Toronto office, where he specialized in both personal and corporate tax planning. Jamie is quoted frequently in the national media as an expert on taxation. He writes a weekly column called “Tax Expert,” in the National Post, has appeared as a guest on BNN, CTV News, and The National, and for several years was a regular personal finance guest on The Marilyn Denis Show. He received his B.Com. from McGill University, earned his CPA designation in Ontario and qualified as a US CPA in Illinois. He has also obtained his Certified Financial Planning (CFP) and Chartered Life Underwriting (CLU) designations. In 2023, Jamie was named a CPA Ontario Fellow. The FCPA is the highest distinction that can be bestowed upon a CPA who brings distinction to themselves and to their profession through leadership and achievement in their professional, community or personal lives. Jamie is a past chair of the Investment Funds Institute of Canada’s Tax Working Group. He is also a member of CPA Ontario, the Illinois CPA Society, the Estate Planning Council of Toronto, the Canadian Tax Foundation and the Society of Trust and Estate Practitioners. For nearly two decades, Jamie taught an MBA course in Personal Finance at the Schulich School of Business at York University in Toronto.