Taxation of investment income within a corporation

Investment Insight

For people with cash or investments in their corporations, the tax cost of withdrawing these funds or winding up the corporation can be quite high. To defer these taxes, individuals often choose to keep a corporation going and concentrate on maximizing its investment returns. Having the corporation invest in a tax-efficient manner can make a big difference to its net after-tax return; unfortunately, the taxation of investment income within a corporation isn’t always well understood.

Let’s review the taxation of corporate investment income.¹

Corporate investment income is taxed as passive income at flat rates that vary by province and territory. There are no graduated tax rates for corporate investment income. The corporate tax rate on investment income is usually higher than the highest personal marginal tax rate and exceeds 50 per cent in many provinces.

Interest income and foreign income, including foreign dividends, are taxed as regular income at the passive income tax rate. A portion of the tax is refundable and added to the refundable dividend tax on hand account (RDTOH).

Capital gains are a more tax-efficient form of income, as only half are taxable (taxable capital gain) and they’re taxed at the passive income tax rate. A portion of the tax is also refundable and added to the RDTOH account. The non-taxable half of the capital gain is added to the capital dividend account (CDA).

Dividends received from taxable Canadian corporations are subject to a 38.33 per cent refundable tax, which is all added to the RDTOH account.

Capital dividend account

No money is actually paid into the CDA. It’s a notional account that includes the non-taxable portion of all capital gains. Corporations can elect to pay a capital dividend, up to the balance in the CDA, and the shareholder receives the dividend tax-free. This is very attractive to shareholders.

Refundable dividend tax on hand account

The RDTOH account is also a notional account. It includes all the 38.33 per cent tax on dividends received from a taxable Canadian corporation. For all other investment income (i.e., interest, foreign income, and taxable capital gains), 30.67 per cent of that income is also added to the RDTOH account. When the corporation pays a taxable dividend to shareholders, it’ll receive a tax refund of $1 for every $2.61 of dividends paid, up to the balance of the RDTOH account. The taxable dividend received by the shareholder is included on their tax return and will be subject to a dividend gross-up and dividend tax credit.

Tip

Where a corporation realizes an increase in the CDA, it’s usually a good idea to pay out the CDA balance promptly (via a tax-free capital dividend). If the CDA balance isn’t paid out, 50 per cent of any subsequent capital losses will reduce the CDA and potential capital dividend.

Taxation of investment income within a Canadian corporation

This graphic shows the taxation of investment income (such as Canadian dividend-paying securities, Guaranteed Investment Certificates/Guaranteed Interest Contracts, or Foreign Dividend-Paying Securities and Mutual Funds/Segregated Funds or Stocks) within a Canadian corporation.

*Assumes corporate tax rate of 51 per cent. 

Comparing the taxation of interest income versus capital gains within a Canadian corporation

Taxation of investment income within a Canadian corporation

 

Interest ($)

Capital gain ($)

Amount

10,000

10,000

Taxable income

10,000

5,000

Tax payable (51%)

(5,100)

(2,550)

Net income

4,900

7,450

RDTOH (30.67% of taxable income)

3,067

1,534

CDA (50% of capital gain not taxable)

-

5,000

*Assumes corporate tax rate of 51 per cent. 

Corporation’s after-tax income

The following table and graph is an example illustrating the taxation of interest income versus capital gains within a Canadian corporation. For illustration purposes only.

*For illustration purposes only 

Comparing the taxation of the investment income flowed out to a shareholder

Taxation of investment income within a Canadian corporation flowed out to a shareholder

 

Interest ($)

Capital gain ($)

Net income (a)

4,900

7,450

Capital dividend (b) (received tax-free)

0

5,000

Dividend tax refund (c) (RDTOH)

3,046

1,523

Taxable dividend (d):  (a) - (b) + (c)

7,946

3,973

Tax on dividend (e): 40%

3,178

1,589

After tax income: (b) + (d) - (e)

4,768

7,384

*Assumes corporate tax rate of 51 per cent.
*Assumes dividend is a non-eligible dividend with a tax rate of 40 per cent. 

Shareholder’s after-tax income

The following table and graph is an example illustrating the taxation of interest income versus capital gains within a Canadian corporation and flowed out to a shareholder. For illustration purposes only.

*For illustration purposes only 

Conclusion

Money that’s invested in a corporation, regardless of the source, should be invested as tax efficiently as possible to mitigate the high corporate tax rates that apply to investment income in a corporation. Just as with individuals, all other things being equal, capital gains are tax preferred over interest income, whether the corporation leaves the income invested to grow or pays it out to a shareholder via a dividend. Understanding the taxation of investment income within a corporation can have a significant impact on the corporation’s and owner’s bottom line.

1 This assumes the corporation is a Canadian-controlled private corporation (CCPC). The taxation of investment income within a corporation can be complex. Consult your tax advisor about how the rules apply to your specific situation. 2 All taxes paid on Canadian dividend income and 30.67 per cent of interest, foreign income, and taxable capital gains are refundable (added to RDTOH). This assumes a corporate tax rate of 51 per cent. 3 For this article, GIC refers to both an insurance company issued guaranteed interest contract as well as a guaranteed investment certificate issued by other financial institutions.

The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund and segregated fund investments. Please read the fund facts as well as the prospectus of the mutual funds, or the information folder, contract, and fund facts of the segregated funds, before investing. Mutual funds and segregated funds are not guaranteed, their values change frequently, and past performance may not be repeated. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

MK2665E 05/21

Tax, Retirement & Estate Planning Services Team

Tax, Retirement & Estate Planning Services Team

Manulife Investment Management

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