How does RDTOH work when my corporation earns investment income?

Why RDTOH exists

Passive investment income earned inside a corporation, such as interest, rents, and taxable capital gains, is taxed at a much higher combined rate than active business income eligible for the small business deduction, roughly 50% in Ontario as at the time of writing. Without a mechanism to unwind part of that tax, the same investment income would effectively be taxed twice: heavily inside the corporation, and again personally once it is eventually paid out as a dividend. Refundable dividend tax on hand (RDTOH) is the mechanism that prevents that double hit, by refunding part of the corporate-level tax once the money is actually distributed.

The roughly 50% rate on corporate investment income is deliberately set close to the top personal tax rate on the same kind of income earned directly, so that earning investment income through a corporation instead of personally provides little or no standalone tax advantage. RDTOH exists specifically to make that comparison fair: without a partial refund mechanism, corporate investment income would simply be taxed at a punishing rate with no ability to recover any of it, which would discourage the use of corporations to hold investments at all.

How the investment income tax splits

Of the roughly 50% combined federal and Ontario tax a CCPC pays on investment income, about 30.67 cents of every dollar earned is added to the corporation’s RDTOH balance rather than being a permanent cost. The remaining tax is the corporation’s genuine, non-refundable cost of earning that income. This structure means the headline rate on passive income looks steep, but a meaningful share of it comes back once dividends flow out, provided the corporation actually pays them.

Eligible RDTOH versus non-eligible RDTOH

Since 2019, RDTOH has been split into two pools. Eligible RDTOH builds mainly from Part IV tax the corporation pays on eligible dividends it receives from other corporations. Non-eligible RDTOH builds from the refundable tax on the corporation’s own investment income and from Part IV tax on non-eligible dividends received. The distinction matters because of how each pool gets paid back out: paying eligible dividends generally draws down eligible RDTOH, while paying non-eligible dividends draws down non-eligible RDTOH first, only reaching into the eligible pool once the non-eligible one is exhausted.

Interest income, foreign income, rental income, and the taxable half of capital gains earned by the corporation all count as aggregate investment income and generate RDTOH. Dividends the corporation receives from Canadian public companies are taxed differently again, generally subject to Part IV tax at a flat rate that is fully added to RDTOH rather than run through the blended aggregate investment income calculation, which is one reason a corporation holding a portfolio of public company shares needs its RDTOH and Part IV tax tracked carefully alongside its regular corporate tax return.

Getting the refund back

A corporation only receives its dividend refund in a year it pays taxable dividends, calculated as the lesser of $38.33 for every $100 of taxable dividends paid, or the RDTOH balance available. A corporation that never pays dividends builds up an RDTOH balance that simply sits there, unrefunded, no matter how much investment income it earns. This is one reason a holding company holding investment assets still needs a dividend policy, not just a place to park cash.

Because the refund only arrives when dividends are actually paid, some corporations time larger dividends for a year when the RDTOH balance has built up meaningfully, rather than paying small dividends every year and leaving a growing, untouched balance behind. This is especially relevant for a holding company accumulating investment income year over year without an immediate need to distribute cash to shareholders, where an annual review of the RDTOH position can reveal a refund opportunity that would otherwise go unused.

Why capital gains are only half the story

Only half of a capital gain is a taxable capital gain included in income, and it is that taxable half, not the full gain, that flows through the RDTOH calculation. The non-taxable half of the gain instead credits the corporation’s capital dividend account, which allows it to be paid out to shareholders entirely tax-free, a separate and often overlooked benefit of investment income earned through a corporation.

How this interacts with dividend designation

The mechanics of RDTOH sit alongside, but are separate from, the rules that determine whether a dividend is eligible or non-eligible. A corporation with both a GRIP balance and an RDTOH balance needs to think about the two together, since the type of dividend paid affects both the personal tax rate the shareholder faces and which RDTOH pool gets refunded. Treating GRIP and RDTOH as one combined planning question, rather than two unrelated year-end calculations, is usually what separates a dividend strategy that recovers the maximum refundable tax from one that leaves a growing, unrefunded balance sitting on the books indefinitely.

How we handle this

We track both RDTOH pools and the GRIP balance together each year, time dividend payments to actually recover the refundable tax rather than letting it sit unused, and factor this into whether a holding company should be paying out its investment income annually. This work runs alongside our corporate tax services for incorporated owners.