Part IV Tax

The purpose of Part IV is to prevent the deferral of dividend income tax from the portfolio through private companies or other closely controlled companies. Since companies are generally allowed to deduct dividend income when calculating their taxable income, Part IV imposes a tax on dividends received from private companies or closely controlled companies in order to remove the incentive for individuals to obtain a significant deferral of dividend income tax. Part IV of the tax is intended to approximate the tax that would be paid by the taxable person with the highest marginal rate if the individual received dividends. Generally, this tax is fully refundable as a corporate dividend refund when the company pays dividends to its shareholders because the shareholders will then be subject to dividend tax at their marginal rates.

  1. Taxable dividends are included in corporate income under paragraph 12 (1) (j) or 12 (1) (k). If a Canadian resident company has received taxable dividends
    (a) A corporation subject to Canadian taxation; or
    (b) a company based in Canada (other than an investment company owned by a company not resident or exempt from Part I) and controlled by the beneficiary, Article 112 allows the beneficiary company to deduct an amount equal to the dividend from the income for the purpose of calculating taxable income. If the Company has received a dividend from a foreign affiliate, the amount calculated in accordance with Section 113 may be deducted from the Company's income for the purpose of calculating taxable income. Although Part I tax is not subject to taxable dividends received by a Canadian domiciled company to the extent such dividends are deductible under Sections 112 or 113, Section 186 may impose Part IV tax on such dividends. As indicated below.
  2. Part IV of the tax applies to "measurable dividends" received by a company that was at any time during the tax period a "private company" or a "relevant company."
    Subsection 186 (3) defines a "measurable dividend" as the amount that a company receives when it is a private company or entity as a taxable person, rather than paying or satisfying it, dividend from the company to the extent of the amount relating to the dividend, is deductible pursuant to § 112 para 113 para. (a), (b), or (d) or subsection 113 (2) in the calculation of the taxable performance of the beneficiary company for the year.
    "Private Company" is defined in Section 89 (1). For a discussion of what constitutes a private company, see the current version of IT-391, Status of Corporations.
    Subsection 186 (3) defines a "corporation in question" as a corporation (other than a private corporation) domiciled in Canada that is controlled, by virtue of a vested interest in one or more trusts or otherwise, or for the benefit of an individual ( other than a trust fund) or a related group of individuals (other than a trust fund). For added certainty, a corporation may be controlled by or for the benefit of an individual or a related group of individuals, even if such control or benefit is derived indirectly through one or more intermediary companies, partnerships, or trusts.
    Part IV of the tax was introduced into the Tax Act to prevent individuals from earning dividends from a Canadian source through corporations and tax deferral. This is possible because companies are not taxed on dividends from other Canadian resident companies.
    Consequently, this dividend is taxed at 38 1/3%, which serves to offset the higher personal tax rate on dividends (note that this is a perfect offsetting, as in some provinces, the higher marginal rate of personal tax on dividends dividend is greater than 38 1/3%, for example in Ontario the highest marginal rate on dividends is 39.34% and the ineligible dividend is 45.30%).
    Part IV of the tax essentially taxes Canadian dividends upfront and returns these prepaid taxes when the company pays the dividends.

New rules have been introduced to better reconcile the reimbursement of taxes paid on passive annuities with the payment of dividends on passive annuities. Under current rules (prior to 2019), companies can obtain redemption of RDTOH dividends generated from investment income by paying dividends that have been taxed at the general corporate tax rate (i.e., the eligible dividend). As eligible dividends are taxed at a lower personal tax rate, this has resulted in a lower effective tax rate on the distribution. The government wants companies to receive RDTOH dividends generated from investment income only if they pay ineligible dividends. To achieve this, the government has introduced two RDTOH accounts: eligible RDTOH and non-eligible RDTOH.

Written By:
Salman Rundhawa
Salman Rundhawa is the founder of Filing Taxes. Salman provides valuable tax planning, accounting, and income tax preparation services in Toronto, Mississauga, Oakville, and Hamilton.

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