Summary: Budget 2018 Tax Update on Passive Investment Income
The Federal Budget of February 27, 2018 introduced two new significant changes to the Income Tax Act (Canada) that could result in greater tax liability for certain corporations earning passive investment income:
1. Corporations that earn passive investment income of more than $50,000 in taxation years beginning after 2018 may not be able to take advantage of the lower small business tax rate (10% for 2018 and 9% for 2019) for the full $500,000 of active business income.
2. Corporations that pay out eligible dividends will only be allowed a refund from Refundable Tax On Hand (“RDTOH”) to the extent of any positive balance in a newly-created “eligible RDTOH” account.
These changes may have real impact on existing and/or planned tax planning strategies for small business owners, in particular.
New Rule #1: Small Business Tax Rate
Budget 2018 reduced the small business tax rate from 10.5% to 10% for 2018 and 9% for 2019. Generally, Canadian-Controlled Private Corporations (CCPCs) can take advantage of the low small business tax rate for active business income up to $500,000 (the “Small Business Limit”) if they do not have “total taxable capital employed in Canada” of more than $10 million.
For taxation years that begin after 2018, CCPCs that earn passive investment income greater than $50,000 will have their Small Business Limit reduced by $5 for every $1 of passive investment income earned above $50,000. CCPCs that earn passive investment income greater than $150,000 for the year will not be able to take advantage of the small business tax rate and will have their entire active business income taxed at the higher, general corporate federal tax rate of 15%.
New Rule #2: Refundable Tax On Hand
The existing rules on RDTOH allow businesses to receive a refund of RDTOH when taxable dividends are paid out, regardless of whether the dividends are eligible or ineligible dividends.
Budget 2018 changed the rules to allow a refund of RDTOH when eligible dividends are paid only to the extent of any positive balance in a CCPC’s “eligible RDTOH” account.
A CCPC’s “eligible RDTOH” account includes refundable taxes paid on receipts of eligible dividends from non-connected Canadian corporations and from connected corporations, if such connected corporations received a refund from its “eligible” RDTOH account for the payment of the eligible dividends. All other refundable taxes will be included in a CCPC’s “non-eligible” RDTOH account.
If non-eligible dividends are paid out, a CCPC will receive a refund of RDTOH, first, from any balance in its “non-eligible” RDTOH account and, second, from its “eligible” RDTOH account, to the extent of the balances in those accounts.
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