CRA comments on the potential conversion of ERDTOH to NERDTOH through inter-corporate dividends

CRA was provided with the following example to illustrate a potential erosion of the eligible refundable dividend tax on hand (ERDTOH) account where a corporation with a ERDTOH and NERDTOH accounts pays an eligible and non-eligible dividend in the same year to two connected shareholders.

Aco has two connected shareholders, each held by the same resident individual (the “Shareholder”): Bco holding all its common shares; and Cco holding all its preferred shares.

At the end of the applicable taxation year, Aco has ERDTOH and NERDTOH balances of $38,333 and $100,000, respectively.

In the course of that taxation year, it paid an eligible dividend to Bco of $100,000, generating a dividend refund (DR) of $38,333 from its ERDTOH account; and it redeemed the preferred shares held by Cco, generating a deemed dividend of $500,000 for which Aco received a DR of $100,000 from its NERDTOH account.

Bco and Cco were subject to Pt. IV tax on such dividends based on the total DR received by Aco, in accordance with s. 186(1)(b):

Bco: $100,000/$600,000 X $138,333 = $23,055;
Cco: $500,000/$600,000 X $138,333 - $115,278.

For Bco, as the dividend received permitted Aco to receive a DR from its ERDTOH, the $23,055 was added to its ERDTOH account. For Cco, as the dividend received did not generate a right to a refund from its ERDTOH, the $115,278 was added to its NERDTOH account.

Thus, there was a conversion of a $15,278 amount from ERDTOH to NERDTOH for the corporate group.

After noting that this ERDTOH-NERDTOH shift resulted “from the fact that paragraph 186(1)(b) makes no connection between the type of RDTOH account entitling Aco to the DR and the type of dividend received by Bco and Cco,” CRA indicated that, here, “the conversion of an amount of ERDTOH into an amount of NERDTOH results in an increase in the tax payable by the Shareholder … but only at … the stage where the amount of dividends paid is limited to the amount necessary to give entitlement to the DR of the ERDTOH and the NERDTOH of Bco and Cco totalling $138,333.” However, CRA indicated that this “conversion of an ERDTOH amount into a NERDTOH amount … does not ultimately result in additional tax to the Shareholder once all of the dividends received from Aco are paid to the Shareholder by Bco and Cco.”

Neal Armstrong. Summary of 10 October 2024 APFF Roundtable, Q.7 under s. 129(4) - NERDTOH.