Many businesses and corporations have different sources of income. For example, apart from their active companies, corporations may have other subsidiaries or investment holdings that can provide them with a source of income.
Corporations with investment holdings receive dividends and interest, or they may record capital gains and losses when they buy or sell their investments.
All of these sources of income are subject to taxes, whether you are an individual or a corporation. So when you’re tax planning for your corporation, it can help you understand how different income types are taxed to optimize your tax planning strategies.
We’ll go through what taxes corporations pay on investment income in Canada, and the concept of refundable taxes for corporations, to help optimize your tax planning.
Corporations pay taxes on all types of income in Canada – whether from their active business or passive income sources, such as investments.
Canada has a flat corporate income tax rate. However, corporations in Canada are subject to federal taxes, as well as provincial taxes, depending on the tax residency of the corporation. As a result, these tax rates may change over time.
Corporations may be eligible for various business tax deductions, depending on their size and business type.
While the corporate tax rate is flat, nuances depend on the corporation’s investment income.
Interest, Rent and Royalty Income
Any type of interest, rent or royalty income is typically subject to the same tax rate as a corporation’s business income.
A portion of the tax is potentially refundable and then added to a notional refundable tax account, which we will discuss in detail below.
In Canada, only 50% of the capital gain is a taxable capital gain. The tax rate on the taxable portion is the same as the corporation’s business income.
A portion of the tax is refundable and added to a notional dividend refundable tax account, which we will discuss later.
Dividends are also subject to tax when a corporation receives them.
Foreign dividend income is generally subject to the same tax rate as all other types of business income, plus a withholding tax. In addition, the corporation can add a portion of the taxes paid to the notional dividend account.
When a corporation receives dividends from Canadian corporations, it pays taxes, and the total amount is added to the notional refundable tax account.
Additional Refundable Tax
A Canadian Controlled Private Company (CCPC) will pay taxes on investment income and corporate taxes on capital gains, interest and other investment income.
This tax is refundable when the corporation distributes profits to its shareholders.
Now that we have covered how different types of income are taxed in a corporation, it is an excellent time to step back and see what happens to the investment income that the corporation receives.
Corporations, like individuals, pay taxes on different types of investment income, including interest, dividends and capital gains. However, corporations may also choose to distribute their earnings. Corporations distribute profits to their shareholders, who are ultimately individuals.
The individual shareholders will now also pay taxes on the same income, which can result in double taxation – first at the corporation level, and again at the hands of the individual.
The primary rationale behind the Canadian tax code is that a dollar of income earned by a corporation should be taxed the same as a dollar earned by the shareholder directly – also known as tax integration.
To avoid double taxation, corporations may receive tax refunds when they distribute their income to shareholders. However, corporations must maintain their refundable dividend accounts to receive their refundable taxes.
As discussed above, when corporations pay taxes on investment income, a portion of the taxes, or the total amount, gets added to a notional dividend account. This notional account is known as Refundable Dividend Tax on Hand (RDTOH), divided into eligible and non-eligible accounts.
These accounts are not actual cash accounts but rather a way for a corporation to track how much tax they have paid on their investment income.
These accounts are essential for any corporation as they can allow them to reduce their tax burden when they pass on the profits to shareholders.
In general, when a corporation pays dividends to its shareholders, it will, in turn, receive a tax refund for the amount up to the balance in its dividend account.
In essence, the corporation has prepaid a tax to the CRA. When it has passed on the tax to the shareholders, it is eligible to receive the taxes refunded back to the corporation.
Generally, a corporation will have to track two types of refundable tax accounts, one for eligible dividends and one for non-eligible dividends.
When corporations earn investment income, it is crucial to understand how much tax the corporation owes and find ways to optimize the tax payments. Corporations typically distribute profits to their shareholders, who are ultimately individuals.
It is essential to consider the corporation’s and its shareholders’ combined overall tax burden to determine the best tax planning strategies.
Contact KSSP Partners LLP in Markham for all your Tax Planning Needs
Talk to an experienced Canadian tax professional to optimize your tax situation. At KSSP Partners LLP, our business and tax advisors can provide personalized tax planning advice for your personal and business taxes. To learn more about how KSSP Partners LLP can provide you with the best tax planning expertise, contact us online or by telephone at 289-554-5997.