The refundable portion of Part I tax is a slice of the federal tax that a Canadian-controlled private corporation pays on its passive investment income, set aside in a notional account and returned to the corporation once it distributes profits to shareholders as taxable dividends. Investment income inside a CCPC is taxed federally at 38⅔%, a rate deliberately close to the top personal bracket so that earning investment income through a corporation offers no meaningful deferral. The refundable mechanism recovers roughly 30⅔ percentage points of that tax when the money is paid out, restoring the integration the system is built around.
Which Corporations the Rules Cover
Only two kinds of corporations generate a refundable portion of Part I tax: a corporation that was a Canadian-controlled private corporation throughout the entire tax year, or a corporation that was a “substantive CCPC” at any point during the year.1Canada Revenue Agency. T2 Corporation Income Tax Guide – Chapter 7: Page 8 of the T2 Return A CCPC is a private corporation resident in Canada that is not controlled by non-residents or public companies. A substantive CCPC sits outside the technical CCPC definition but is still effectively controlled by Canadian-resident individuals; the category was added to close a planning route where ownership was restructured to escape CCPC treatment on investment income.2Justice Laws Website. Income Tax Act – Section 248
Public corporations and corporations controlled by non-residents do not qualify. If a corporation loses its CCPC status partway through the year, the refundable portion of Part I tax does not apply for that year. Substantive CCPC status works differently: being a substantive CCPC at any point during the year is enough to trigger the rules.
What Income the Refund Applies To
The refundable portion of Part I tax attaches only to “aggregate investment income,” meaning income earned from wealth rather than from active business operations. Under section 129(4) of the Income Tax Act, aggregate investment income has two components: net taxable capital gains and income from property sources.3Justice Laws Website. Income Tax Act – Section 129
The capital gains component is the taxable portion of capital gains for the year, minus allowable capital losses and any net capital losses carried forward from prior years. For corporations, the capital gains inclusion rate rises from one-half to two-thirds effective January 1, 2026, so two-thirds of any capital gain becomes taxable.4Department of Finance Canada. Government of Canada Announces Deferral in Implementation of Change to Capital Gains Inclusion Rate Only gains on passive assets qualify. Capital gains from selling assets used in an active business are excluded.
The property component covers interest, rents, and royalties from passive sources. Dividends are generally excluded because they are taxed separately under Part IV. Income from a specified investment business carried on in Canada also counts as property income here. The total is reduced by any losses from property sources during the year, and the figures are worked out on Schedule 7 of the T2.5Canada Revenue Agency. T2SCH7 Aggregate Investment Income and Income Eligible for the Small Business Deduction
How the Refundable Portion Is Calculated
The refundable portion of Part I tax is the least of three amounts, as set out in the definition of non-eligible refundable dividend tax on hand in section 129(4).3Justice Laws Website. Income Tax Act – Section 129
- 30⅔% of the corporation’s aggregate investment income, reduced by the excess of the foreign non-business income tax credit over 8% of the corporation’s foreign investment income. That subtraction blocks a double benefit where the same income would generate both a foreign tax credit and a refundable amount.
- 30⅔% of the corporation’s taxable income that exceeds the income eligible for the small business deduction. This keeps the refundable portion tied to income taxed at the full corporate rate, not to income already sheltered by the small business rate.
- The corporation’s Part I tax payable for the year after all other credits, so the refundable portion never exceeds the tax actually paid.
The first amount usually controls the calculation when a corporation has substantial investment income and little foreign tax credit exposure. The second binds when a large share of taxable income qualifies for the small business deduction. The third is a backstop that rarely drives the result unless credits have chewed through the Part I liability.1Canada Revenue Agency. T2 Corporation Income Tax Guide – Chapter 7: Page 8 of the T2 Return The general rate reduction of 13% that applies to most corporate income does not apply to a CCPC’s investment income.6Canada Revenue Agency. Corporation Tax Rates
Where the Amount Sits: NERDTOH and ERDTOH
Before 2019, refundable taxes lived in a single account called Refundable Dividend Tax on Hand. The 2018 federal budget split it into two: Eligible RDTOH (ERDTOH) and Non-Eligible RDTOH (NERDTOH). The split matters because it dictates what type of dividend the corporation must pay to trigger a refund.7Canada Revenue Agency. T2 Corporation Income Tax Guide – Chapter 6: Pages 6 and 7 of the T2 Return
The refundable portion of Part I tax flows exclusively into NERDTOH. That account also receives certain Part IV taxes on dividends received from other corporations. ERDTOH, by contrast, is built from Part IV tax on eligible dividends received from non-connected corporations, and from dividends received from connected corporations to the extent those dividends triggered a refund out of the payer’s ERDTOH.3Justice Laws Website. Income Tax Act – Section 129 Both accounts carry forward indefinitely until the corporation pays dividends.
Claiming the Refund
The corporation gets its money back by paying taxable dividends. The refund rate is 38⅓% of the dividends paid, capped at the balance in the relevant RDTOH account.3Justice Laws Website. Income Tax Act – Section 129 A corporation paying $100,000 in dividends can recover up to $38,333, provided the RDTOH balance supports it.
The type of dividend controls which account the refund draws from. Eligible dividends draw only from ERDTOH. Non-eligible dividends draw from NERDTOH first; if the NERDTOH balance is exhausted before the full 38⅓% has been recovered, the remainder can be drawn from ERDTOH to the extent of any balance there not already used by eligible dividends.
The ordering is deliberate. Because the refundable portion of Part I tax sits in NERDTOH, recovering it requires paying non-eligible dividends, which are taxed more heavily in the shareholder’s hands and preserve the integration the system is designed to achieve. A corporation that pays only eligible dividends will never clear its NERDTOH balance.7Canada Revenue Agency. T2 Corporation Income Tax Guide – Chapter 6: Pages 6 and 7 of the T2 Return
The dividend has to be documented in the corporate records, and recipients need the appropriate tax slips. The CRA can process the refund automatically when it assesses the T2, or the corporation can apply for it in writing. Either way, the return must be filed within three years of the end of the tax year to preserve the refund entitlement.3Justice Laws Website. Income Tax Act – Section 129 Any refund is applied first against outstanding tax debts before the balance is issued, so the notice of assessment is worth checking against internal calculations.
Passive Income and the Small Business Deduction
The refundable portion of Part I tax is not the only consequence of holding investment assets inside a CCPC. Since 2019, adjusted aggregate investment income also chips away at access to the small business deduction, which taxes the first $500,000 of active business income at a much lower rate.
The grind starts once the corporation and any associated corporations earn more than $50,000 in adjusted aggregate investment income in the preceding tax year. Each dollar over $50,000 reduces the business limit by $5. At $150,000 of passive income, the small business limit is reduced to zero.8Justice Laws Website. Income Tax Act – Section 125
A corporation that hits $150,000 of passive income in one year loses its entire small business deduction the following year, pushing all active business income to the general corporate rate. Associated corporations share the $50,000 threshold, so two related corporations that together cross $50,000 both see their limits reduced.
Filing the Return
The T2 return is due no later than six months after the end of the fiscal year. The refundable portion of Part I tax and the resulting NERDTOH balance are calculated on Schedule 7 for the aggregate investment income figures, with the RDTOH accounts and dividend refund reported on pages 6 and 7 of the T2.7Canada Revenue Agency. T2 Corporation Income Tax Guide – Chapter 6: Pages 6 and 7 of the T2 Return Discrepancies between Schedule 7 and the amounts flowing through the RDTOH accounts are one of the more common triggers for CRA review, so consistent records on passive income sources through the year save trouble at filing time.