Deadline deals

Corporations have three years to get dividend refund

Small-business owners are often encouraged to leave surplus funds in their corporations so as to enjoy a substantial tax deferral on money they don’t need currently to fund lifestyle spending. By leaving excess funds in the corporation, personal tax can be deferred until the funds are ultimately withdrawn from the company.

On investment income and capital gains earned inside a Canadian private corporation, a federal refundable tax of 26.67% must be paid and that balance is included in the corporation’s notional Refundable Dividend Tax on Hand (RDTOH) account. On taxable dividends paid out to shareholders, a dividend refund equal to 33.33% of the dividends paid (up to the balance in the RDTOH account) is refunded to the corporation.

The purpose of this rule is to ensure that corporations initially pay about 50% in total federal and provincial tax on investment income, eliminating the incentive to earn investment income in a corporation rather than personally, where the top marginal rate is also about 50%, depending on your province of residence. That said, once sufficient dividends are paid out, the dividend refund mechanism combined with the gross-up and dividend tax credit system ensure that the total tax paid on investment income earned through a corporation and paid out as a dividend is roughly equal to the tax payable had the individual earned that investment income personally.

In order for a corporation to get its dividend refund for a particular tax year, however, it must file its tax return for that year within three years. If the three-year deadline is missed, there seems to be no solution — as an Ontario company recently found out.

The numbered company found itself in the Federal Court of Appeal this fall when it was denied a dividend refund because it had not filed a tax return for any of the relevant taxation years within three years from the end of each year. The lower court tax judge held that the failure to file a tax return within three years from the end of the taxation year during which the dividend was paid simply “precluded the Appellant from receiving the dividend refund for that year.”

This harsh result echoes a statement made by the Canada Revenue Agency in 2011 concerning the rule: “We cannot envision a situation in which an action… would enable a taxpayer to obtain a dividend refund beyond the period described.”

This recent case serves as yet another harsh reminder that missing tax deadlines can have severe consequences.

“WE CANNOT ENVISION A SITUATION IN WHICH AN ACTION… WOULD ENABLE A TAXPAYER TO OBTAIN A DIVIDEND REFUND BEYOND THE PERIOD DESCRIBED”