Part IV tax

When it applies

Part IV tax applies to taxable dividends that are deductible when computing taxable income, such as ordinary dividends from other Canadian corporations, but only if the recipient is a private or subject corporation when it receives them. A holding company that owns shares of an unrelated corporation is the typical case. It is reported on Schedule 3 and entered on line 712 of the T2 return.

Whether the payer is connected matters. A payer is connected if the recipient controls it, meaning more than 50% of its voting share capital belongs to the recipient or to non-arm’s-length persons. It is also connected if the recipient owns more than 10% of the voting share capital and shares worth more than 10% of the payer’s total share value. Dividends from a connected payer attract the tax only when they generate a dividend refund for the payer.

Why it is refundable

Part IV tax feeds the corporation’s refundable dividend tax on hand accounts. Part IV tax on eligible dividends from non-connected corporations goes to the eligible account, ERDTOH. Most of the rest goes to the non-eligible account, NERDTOH, while tax on connected-corporation dividends follows the refund the payer received. When the corporation pays taxable dividends, it may receive a dividend refund. For eligible dividends paid, the refund is the lesser of 38 1/3% of those dividends and the ERDTOH balance.

The refund must be claimed by filing the return within three years of the tax year-end, or it becomes statute barred. Dividends paid from the capital dividend account do not qualify for a refund.

A simple illustration

For illustration, an Ontario holding company receives $10,000 in eligible dividends from a public company it owns a small stake in. The payer is not connected, so Part IV tax is about $3,833, which is 38 1/3% of $10,000. That amount is added to ERDTOH. If the holding company later pays $10,000 in eligible dividends to its shareholder, it could recover up to that $3,833, depending on its balance. The example ignores loss deductions and other adjustments.

Common mistakes

Some owners treat dividends between corporations as tax-free because they are deductible. The deduction removes Part I tax, but Part IV may still apply. Others forget Schedule 3 when the dividend comes from a related corporation. Non-capital losses can reduce the dividends subject to Part IV tax, so keep loss records. Our small business deduction and eligible dividend entries cover related rules.

What to discuss with your accountant

Ask which of your corporations hold shares in others, whether each payer is connected, and what your ERDTOH and NERDTOH balances are. Bring dividend slips, share ownership records and prior Schedule 3 filings. The refund timing can affect personal dividend planning, so raise both together.