Intercorporate dividends

Why they are treated differently

When a corporation pays a dividend to an individual, the individual reports it as income. When the shareholder is itself a corporation, the CRA generally lets the recipient deduct most taxable dividends it receives from Canadian corporations. On the T2 return that deduction is entered on line 320, and the dividends are reported on Schedule 3. The aim is to avoid taxing the same profit again each time it moves up a chain of companies.

The deduction is not the end of the story for private companies. A private or subject corporation that receives these dividends may owe Part IV tax, a separate tax calculated on Schedule 3 and entered on line 712.

When Part IV tax applies

The CRA draws the line at whether the payer is connected to the recipient. A payer is connected if the recipient controls it, meaning the recipient and people it does not deal with at arm’s length hold more than 50% of the voting share capital. It is also connected if the recipient owns more than 10% of the voting share capital and shares worth more than 10% of the value of all the issued share capital.

For dividends from a non-connected corporation, Part IV tax is 38 1/3% of the dividend. For dividends from a connected corporation, Part IV tax applies only when the payment gives the payer a dividend refund. Schedule 3 needs a separate calculation for each paying corporation, and certain losses can reduce the dividends subject to the tax.

Part IV tax is generally not a permanent cost. For a Canadian-controlled private corporation it feeds refundable dividend tax on hand, which can be recovered when the corporation later pays taxable dividends to its own shareholders.

An illustrative example

Suppose an operating company owned entirely by a holding company pays it a $100,000 dividend. The holding company deducts the dividend in calculating taxable income. Whether Part IV tax is also payable depends on whether the operating company received a dividend refund for paying it. The result is a tax calculation, not a choice you make on the return.

Now suppose the holding company owns 5% of an unrelated company and receives a $10,000 dividend. That payer is not connected, so Part IV tax before reductions would be $3,833. The figures are illustrative and ignore losses and any later refund.

What to discuss with your accountant

Ask whether your holding company and operating company are connected for Part IV purposes, and how that affects the timing of dividends. Bring the share ownership records, the dividend resolutions and the paying corporation’s year-end, since the two year-ends can differ.

Discuss what happens to any Part IV tax paid, how it will be tracked, and how it fits with salary and dividend planning for the owners.