How Investment Income Is Taxed in Corporations

Executive Summary

Investment income in Canadian corporations is taxed differently than active business income. Here's what matters:

• High flat rates: Investment income is taxed at flat rates (often 50%+):no graduated rates like personal income
• Different income types, different tax treatment: Interest and foreign income are fully taxable. Capital gains are 50% taxable. Canadian dividends have special refundable tax
• Refundable tax: Part of the tax is refundable through RDTOH accounts:you get it back when you pay dividends
• CDA credits: Capital gains create CDA credits, allowing tax-free distribution of the non-taxable portion
• After-tax results matter: The same gross return can produce very different after-tax results depending on income type

This article explains how different income types are taxed in corporations and what this means for your investment strategy.

Mindset: Tax Structure Affects After-Tax Returns

Before diving into the technical details, let's think about this from a results perspective.

The same investment return can produce very different after-tax results depending on how the income is structured. A 5% return from interest is taxed differently than a 5% return from capital gains. Over time, these differences compound.

The Big Picture:

1. Tax rates vary by income type: Interest, capital gains, dividends, and foreign income are all taxed differently
2. Refundable tax matters: Some corporate tax is refundable when you pay dividends:this affects total tax paid
3. CDA credits add value: Capital gains create CDA credits that allow tax-free distribution
4. Structure affects outcomes: How you structure investments (corporate class funds, asset allocation, etc.) affects tax treatment

The mindset shift: from "all investment income is taxed the same" to "income type affects after-tax results, and structure matters."

How Investment Income Is Taxed: The Basics

Investment income in Canadian-controlled private corporations (CCPCs) is taxed as passive income at flat rates. Unlike personal income tax (which has graduated brackets), corporate investment income faces a single high rate.

Tax Rates

Corporate tax rates on investment income vary by province but are generally:

• 50% or higher in most provinces
• Flat rate (no graduated brackets)
• Higher than top personal marginal rates in most cases

This high rate is why tax-efficient investing matters in corporations.

Different Income Types, Different Tax Treatment

Not all investment income is taxed the same way. Here's how each type is treated:

Interest Income

Tax treatment:

• Fully taxable at passive income rates
• Taxed at approximately 50%+ depending on province
• Creates NERDTOH (Non-Eligible Refundable Dividend Tax on Hand)

Example: $10,000 of interest income

• Taxable: $10,000
• Tax at 51%: $5,100
• After-tax: $4,900
• NERDTOH: $3,067 (refundable when dividends paid)

Key point: Interest income is fully taxable with no special benefits.

Foreign Income (Including Foreign Dividends)

Tax treatment:

• Fully taxable at passive income rates
• Taxed at approximately 50%+ depending on province
• Creates NERDTOH
• May be subject to foreign tax credits

Example: $10,000 of foreign income

• Taxable: $10,000
• Tax at 51%: $5,100
• After-tax: $4,900
• NERDTOH: $3,067 (refundable when dividends paid)

Key point: Foreign income is taxed similarly to interest income.

Capital Gains

Tax treatment:

• Only 50% taxable (the "taxable capital gain")
• Taxed at passive income rates on the taxable portion
• Creates NERDTOH on the taxable portion
• Creates CDA credit on the non-taxable portion (50% of the gain)

Example: $10,000 capital gain

• Taxable: $5,000 (50% of $10,000)
• Tax at 51%: $2,550
• After-tax: $7,450
• NERDTOH: $1,534 (refundable when dividends paid)
• CDA: $5,000 (can be paid tax-free)

Key point: Capital gains are more tax-efficient because only half is taxable, and the non-taxable portion can be distributed tax-free through the CDA.

Canadian Dividends (Eligible)

Tax treatment:

• Subject to 38.33% refundable tax
• All tax is refundable (added to ERDTOH)
• Creates ERDTOH (Eligible Refundable Dividend Tax on Hand)

Example: $10,000 eligible dividend

• Taxable: $10,000
• Refundable tax at 38.33%: $3,833
• After-tax: $6,167
• ERDTOH: $3,833 (all refundable when eligible dividends paid)

Key point: All tax on eligible Canadian dividends is refundable, making them tax-efficient when paid out as eligible dividends.

Refundable Tax: RDTOH Accounts

Part of the tax paid on investment income is refundable. This means you can get some of it back when you pay dividends.

NERDTOH (Non-Eligible Refundable Dividend Tax on Hand)

What it tracks:

• Refundable tax on interest income
• Refundable tax on foreign income
• Refundable tax on taxable capital gains

How it works:

• 30.67% of interest, foreign income, and taxable capital gains is added to NERDTOH
• When you pay non-eligible dividends, you get a refund: $1 refund for every $2.61 of dividends paid
• Refund is limited to your NERDTOH balance

Example: You have $10,000 NERDTOH balance

• You pay $26,100 in non-eligible dividends
• You receive $10,000 tax refund
• Your NERDTOH balance is reduced to $0

ERDTOH (Eligible Refundable Dividend Tax on Hand)

What it tracks:

• Refundable tax on eligible Canadian dividends received

How it works:

• 38.33% of eligible dividends received is added to ERDTOH
• When you pay eligible dividends, you get a refund: $1 refund for every $2.61 of dividends paid
• Refund is limited to your ERDTOH balance

Key point: Refundable tax reduces the effective tax rate when dividends are paid, but you need to pay dividends to get the refund.

Capital Dividend Account (CDA) Credits

Capital gains create CDA credits, which allow tax-free distribution to shareholders.

How CDA Credits Work

When your corporation realizes a capital gain:

• 50% is taxable (creates NERDTOH)
• 50% is non-taxable (creates CDA credit)

The CDA credit can be paid as a capital dividend, which is received tax-free by shareholders.

Example: $10,000 capital gain

• Taxable portion: $5,000 (taxed, creates NERDTOH)
• Non-taxable portion: $5,000 (creates CDA credit)
• Corporation can pay $5,000 capital dividend tax-free

Key point: CDA credits make capital gains particularly tax-efficient because part of the gain can be distributed tax-free.

Comparing Income Types: After-Tax Results

Let's compare how $10,000 of different income types flows through to shareholders:

Interest Income

At corporate level:

• Income: $10,000
• Tax at 51%: $5,100
• After-tax: $4,900
• NERDTOH: $3,067

When paid as dividend:

• Dividend refund: $3,046 (from NERDTOH)
• Taxable dividend: $7,946 ($4,900 + $3,046)
• Personal tax at 40%: $3,178
• Net to shareholder: $4,768

Capital Gains

At corporate level:

• Gain: $10,000
• Taxable: $5,000
• Tax at 51%: $2,550
• After-tax: $7,450
• NERDTOH: $1,534
• CDA: $5,000

When paid out:

• Capital dividend (tax-free): $5,000
• Dividend refund: $1,523 (from NERDTOH)
• Taxable dividend: $3,973 ($7,450 - $5,000 + $1,523)
• Personal tax at 40%: $1,589
• Net to shareholder: $7,384

Result: Capital gains provide significantly better after-tax results than interest income.

How to Apply: Structuring Your Corporate Portfolio

Understanding how different income types are taxed helps you structure your corporate portfolio for better after-tax results.

Step 1: Understand Your Current Income Mix

Work with your CPA to identify:

• What types of income your portfolio generates
• How much of each type you're earning
• What your current tax cost is

Step 2: Consider Tax-Efficient Structures

Based on income type taxation:

• Capital gains are most efficient (50% taxable, CDA credits)
• Corporate class funds can convert interest/dividends to capital gains
• Asset allocation affects income type mix

Step 3: Coordinate with Other Tax Rules

Consider how investment income affects:

• SBD grind: Passive income above $50K reduces small business deduction
• RDTOH balances: Refundable tax is only recovered when dividends are paid
• CDA credits: Should be paid out promptly to avoid reduction from capital losses

Step 4: Plan Dividend Strategy

Work with your CPA to plan:

• When to pay dividends (to recover RDTOH)
• What type of dividends to pay (eligible vs non-eligible)
• How to use CDA credits (capital dividends)

Step 5: Review Regularly

Tax rules and your situation change:

• Review income mix annually
• Monitor RDTOH and CDA balances
• Adjust strategy as needed

Worked Example: Portfolio Comparison

Let's compare two portfolios earning the same gross return but with different income structures:

Portfolio A: Interest-focused

• $1,000,000 invested
• 5% annual return = $50,000 interest income
• Tax at 51%: $25,500
• After-tax: $24,500
• NERDTOH: $15,335

Portfolio B: Capital gains-focused

• $1,000,000 invested
• 5% annual return = $50,000 capital gains
• Taxable: $25,000
• Tax at 51%: $12,750
• After-tax: $37,250
• NERDTOH: $7,668
• CDA: $25,000

After 10 years (assuming reinvestment):

Portfolio A:

• After-tax value: ~$270,000
• Total tax paid: ~$255,000

Portfolio B:

• After-tax value: ~$370,000
• Total tax paid: ~$127,500
• CDA available: ~$250,000 (can be paid tax-free)

Result: Capital gains-focused portfolio leaves significantly more after-tax capital, even with the same gross return.

Decision Checklist

Understanding investment income taxation matters if:

• [ ] Your corporation holds investments (mutual funds, stocks, bonds, GICs, etc.)
• [ ] You're earning passive investment income
• [ ] You want to optimize after-tax returns
• [ ] You're considering different investment structures
• [ ] You want to understand how dividends affect your tax situation
• [ ] You're planning to pay dividends from your corporation

If several of these apply, work with your CPA to understand how investment income taxation affects your specific situation.

Important Notes

This is educational information. Investment income taxation is complex and depends on your specific corporate structure, province, and circumstances. Tax rules are subject to change. Always consult with your CPA before making investment or tax decisions.

Tax rates vary by province. The examples use approximate rates (51% corporate tax). Actual rates vary by province and may change. Work with your CPA to understand rates that apply to your corporation.

RDTOH refunds require dividends. Refundable tax is only recovered when you pay dividends. If you don't plan to pay dividends, the refundable tax remains in the corporation.

CDA credits should be used promptly. If you don't pay capital dividends, capital losses can reduce your CDA balance. Work with your CPA to plan CDA distributions.

Mutual funds are offered through WhiteHaven Securities Inc. Mutual funds are distributed through WhiteHaven Securities Inc. Insurance products and related services are provided through iAssure Inc., an independent firm in the insurance of persons and in the group insurance of persons. These activities are neither the business nor the responsibility of WhiteHaven Securities Inc.

Next Steps

If investment income taxation affects your situation:

• Understand your income mix: Work with your CPA to identify what types of income your portfolio generates
• Review tax efficiency: Consider whether your portfolio structure optimizes after-tax returns
• Plan dividend strategy: Coordinate with your CPA on when and how to pay dividends
• Monitor balances: Track RDTOH and CDA balances regularly
• Coordinate with your team: Work with your investment advisor, CPA, and lawyer to optimize your structure

If you'd like to discuss your specific situation, request a structure review to see if there's a fit.