RDTOH and Business Valuations – HoldCo and Opco Impacts

By Abhi Mathews, CFA, CBV

In this piece, we will outline one key change that impacted Canadian businesses and business owners, especially select high net worth business owners, many of whom have been employing the tax deferral strategy, some for decades, to their businesses’ benefit. In our subsequent blog piece, we will discuss the tax impact on U.S. businesses, with the new proposals passed.

On July 18, 2017, draft legislative proposals were released relating to the Income Tax Act, by  the Department of Finance, which spoke about the elimination of the RDTOH (side note – we will assume that that the reader here owns a business or understands the basics of the RDTOH). The proposal at the time introduced legislations, per our understanding, to eliminate it – thereby pushing investment income rates, in Ontario, to 50.17% versus the 19.50% (after the refundable dividend tax on hand was distributed – of 30.67%).

Subsequent to that, on June 6, 2018, Bill C-74 was passed, and this bill provided clarity on the RDTOH issue. Now while there are quite a few tax technicalities, we attempt to summarize this from a high level so that even non-accountants can understand it – please contact your tax accountant to get actual advise, on the matter. Per our understanding, there has been a limit of $50,000 in investment income placed on CCPC’s as it relates to investment income. As such, any investment income over $50,000 would be subject to a grind down in the small business deduction (“SBD”), i.e. a $5 grind-down in the limit for every $1 in excess of $50,000 of the “adjusted aggregate investment income”, in the preceding calendar year for the CCPC and all associated CCPCS. So $150,000 in investment income will wipe the SBD of the CCPC or any associated CCPC’s, claiming the SBD.

This new Bill C-74 also states that out of the CCPC’s existing RDTOH at the end of the previous taxation year, an amount equal to 38⅓ per cent of the CCPC’s GRIP, at the end of the previous year (basically, taxable income that was subject to the general corporate rate) will be allocated to its eligible RDTOH. The remainder of the existing RDTOH, if any, will be allocated to the CCPC’s non-eligible RDTOH.

What in the world does all of this mean, you ask as a business owner or a non-accountant? It means that if one has an associated Holdco or has investment income exceeding $50,000, then it has the potential to affect the tax rates of the associated OpCo or CCPC, itself. If the investment income exceeds $150,000, then it has the ability to wipe out the small business deduction and force the Opco to the Non CCPC income tax rate. Please contact your Tax CPA for all the details.

From a valuation perspective, all things equal, this should move the valuations of many entities lower as quite a few of them will have their SBD, grinded down on 5:1 basis, for every dollar above the $50,000 threshold. 

On the issue of taxes, we think that private businesses rather than government create most of the jobs and thus growth in cities and towns; furthermore, many business owners don’t have a pension, vacation pay or other benefits, until later in the business’ life and thus penalizing businesses, is a short term strategy, will see capital flight (human or financial) to higher returning environments. 

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