Introduction

The Refundable Dividend Tax on Hand (RDTOH) is one of the more technically complex — and practically important — elements of corporate tax for incorporated professionals and small business owners whose corporations hold passive investments. It is the mechanism that prevents investment income inside a corporation from being permanently taxed at an unfairly high rate compared to personal investment income.

The Integration Principle Behind RDTOH

The Canadian tax system is designed on a principle of integration: a dollar of income should bear roughly the same total tax burden whether it is earned personally or through a corporation. For active business income within the small business deduction limit, integration is largely achieved through the coordinated corporate and personal tax rates.

For passive investment income, integration is achieved through a different mechanism. Passive income is taxed at a high rate inside the corporation — approximately 50.17% combined in Ontario — to approximate the highest personal marginal rate. But part of that tax is designated as refundable. When the corporation pays a dividend to the shareholder (who pays personal dividend tax on receipt), a portion of the corporate tax paid on the passive income is refunded to the corporation.

The net result is intended to be the same total tax burden as if the income had been earned personally — not more, not less.

The Two RDTOH Pools

Since 2019, there are two separate RDTOH pools: eligible RDTOH and non-eligible RDTOH.

Eligible RDTOH is generated from eligible portfolio dividends (dividends from non-connected public Canadian corporations that themselves paid eligible dividends). This pool is refunded only when the corporation pays eligible dividends.

Non-eligible RDTOH is generated from other types of passive income — interest, capital gains, and non-eligible dividends. This pool is refunded when the corporation pays either eligible or non-eligible dividends (though the CRA requires non-eligible RDTOH to be refunded first when non-eligible dividends are paid).

The distinction between eligible and non-eligible RDTOH was introduced to prevent a specific tax advantage where corporations were earning eligible dividends (taxed at a lower effective rate under the previous rules) and claiming RDTOH refunds that exceeded what was appropriate.

The Refund Rate

The refundable portion of tax on passive income is 38.33% of the income included in the RDTOH calculation. For every $3 of taxable dividends paid by the corporation, $1 of RDTOH is refunded (i.e., a refund of $1 for every $3 in dividends, capped at the RDTOH balance).

This refund is reported on Schedule 3 of the T2 return and is applied as a credit against the corporation's tax liability (or as a refund if the RDTOH balance exceeds tax owing).

Why RDTOH Matters in Practice

For a corporation that has accumulated significant passive investment income, the RDTOH account represents a future tax refund that will be realised when dividends are paid. This makes the RDTOH balance a corporate asset — one that should be tracked and incorporated into dividend planning.

A corporation with a large RDTOH balance should be paying sufficient dividends to trigger the refund annually — allowing the refunded tax to re-enter the invested pool rather than sitting as an unrealised credit.

A corporation that has been accumulating passive income for years without paying dividends may have a large RDTOH balance that is not being utilised. This is not necessarily a problem — the refund is available whenever dividends are paid — but understanding the balance and incorporating it into distribution planning is part of good corporate tax management.

RDTOH and the Dividend Strategy

The choice between eligible and non-eligible dividends affects which RDTOH pool is drawn down. Non-eligible dividends draw from non-eligible RDTOH first, then eligible RDTOH. Eligible dividends draw only from eligible RDTOH.

For corporations with both pools, the order and type of dividends paid affects how the refund is allocated and potentially the personal tax rate applicable to the dividend on the shareholder's return. This is a nuanced planning point that requires reviewing the specific balances.

When to Speak With a CPA

RDTOH tracking, the distinction between eligible and non-eligible pools, and the interaction with dividend strategy are part of the annual T2 preparation for any corporation with passive income. If your corporation holds investments and you have never had a specific conversation with your CPA about your RDTOH balance and how it affects your dividend strategy, it is worth raising.

Rotaru CPA helps incorporated professionals and business owners integrate RDTOH management into their annual compensation and distribution planning. Book a consultation to review your position.