Refundable Dividend Tax on Hand (RDTOH)

The RDTOH As A Tax-Efficient Strategy For Private Business Owners To Donate Shares From Their Company

The Refundable Dividend Tax on Hand (RDTOH) is an important notional (not real) account on the books of Canadian private corporations.  It has two important components: (1) a refundable portion of Part I tax on investment income (capital gains and interest only); and (2) a refundable portion of Part IV tax on taxable dividends received from unrelated companies.

So, what is so important about the RDTOH account?  When a private company pays out taxable dividends to its shareholders, it can claim a refund from the Canada Revenue Agency (“CRA”) equal to one dollar for every three dollars of taxable dividend paid.  Generally speaking, the maximum amount that can be refunded in cash to the company is the balance of the RDTOH account. The payment of a taxable dividend may be denied by CRA using 129(1.2) thus negating the dividend refund.

Gifts from private companies are also often used as part of a company restructuring or wind down.  If the company redeems the shares the proceeds received by the shareholder could be deemed a dividend subject to income tax.  Therefore, in the right situation, redeemable preferred shares are a good way to make a gift because the valuation is relatively simple, and if the company has the cash, they can be readily redeemed (no need to hunt for a buyer).

Example: RDTOH

Bob has retired from his company some time ago.  His tax advisors set up a trust to own the common shares, and he was issued fixed value preferred shares (“Estate Freeze Shares”) that pay him an annual dividend.  In this example, assume Bob’s tax rate is 46%, the donation tax credit is also 46%, and the Estate Freeze Shares have a nil cost base and no paid-up capital.  In other words, the entire value of the shares will be a capital gain when disposed or gifted.   Furthermore, the company has a balance in its RDTOH account and excess cash in the bank sufficient to redeem the shares if required.

Bob’s wife had passed recently from a protracted battle with cancer.  His wife was in and out of the hospital for years, and he was very grateful to the hospital staff that had worked so hard to help her.  Bob arranges to gift $250,000 of his preferred shares in memory of his wife to the hospital for the benefit of the cancer ward.  Given that Bob is at arm’s length to the hospital, the shares qualify as an excepted gift, hence he receives a $250,000 tax receipt immediately.  Bob will have a taxable gain of $125,000 (50% of the capital gain) that will attract $57,500 in new taxes ($125,000 X 46%).  The resulting tax credit saves Bob $57,500 in net tax savings ($115,000-$57,500 in tax).

The charity elects to redeem the shares promptly.  The company pays out a $250,000 taxable deemed dividend to the charity (now a shareholder) for the shares.  Additional tax benefits may be available using this gift plan. Please consult your financial advisor for other shareholder/corporate benefits.

This article is not intended to convey tax and or legal advice and is for illustration purposes only. Anyone interested in the strategy should seek guidance from their financial and/or legal advisor before making a gift. This content has been revised by Benefaction with permission from the author, DeWayne Osborn of Cardinal Capital Management, Inc. in Winnipeg.