Denika Heaton, BBA, JD, TEP, CEA Tax and Estate Planning Specialist, Private Wealth
Chris Hanley, CPA, CA, CFP Tax and Estate Planning Specialist, Private Wealth

Key Takeaways: 

• Investment income earned in your corporation faces an immediate tax of approximately 50%, but part of that tax can be refunded when you pay yourself dividends. Knowing how these refundable tax accounts work can help you plan withdrawals more effectively.
• Passive investment income above $50,000 annually in your corporation can reduce or eliminate your small business deduction, increasing corporate tax on your active business income.
• The order in which you withdraw funds matters: prioritize tax-free capital dividends first, followed by dividends that generate corporate tax refunds, so you preserve as much after-tax wealth as possible.
• Not all dividends are taxed equally. Eligible dividends are taxed more favourably than non-eligible dividends, so choosing the right mix is an important part of your planning.

What happens when your corporation generates more profit than you need for personal expenses?  For many business owners, the answer is straightforward: leave the surplus funds in the company (or a holding company) to grow and compound. But earning investment income inside your corporation can create tax consequences that affect both your corporate taxes and retirement planning. Let’s explore how corporate investment taxation works, examine how investment income can affect your small business deduction, and provide practical strategies for withdrawing funds tax efficiently, especially as you plan for retirement.

Corporate Tax Concepts: Refundable Taxes on Investment Income

When your private Canadian corporation earns “passive” investment income — such as interest, dividends, rental income, royalties, or taxable capital gains — it’s taxed differently than your active business profits. Investment income is subject to higher flat corporate tax rates similar to the highest personal marginal tax rates. However, a portion of this tax can be refunded when your corporation pays taxable dividends to you as a shareholder. 

This refundable tax system aims to ensure that the total tax paid on investment income is roughly the same whether you earn it personally or first through your corporation, minimizing any long-term tax deferral advantage from retaining investment income inside the company.

When the corporation pays you taxable dividends, it receives a refund of a portion of the taxes previously paid on investment income. These refundable amounts are tracked in the corporation’s Refundable Dividend Tax on Hand (RDTOH) accounts.

Below are the tax rates applicable to investment income, other than taxable Canadian dividends. 

Note: For simplicity, this discussion does not address foreign investment withholding taxes. Tax rates sourced from CRA as of November 2025

As you can see, immediate tax on investment income earned within a corporation is substantial, around 50% in most provinces. However, once the corporation pays taxable dividends to the shareholder, the net corporate tax drops significantly.

Note: Taxable Canadian dividends received by your corporation are subject only to federal refundable taxes of 38.33%.

Understanding Your Corporation's Tax Accounts

A corporation’s RDTOH accounts are subdivided into two subaccounts:

Eligible Refundable Dividend Tax on Hand (ERDTOH)

This notional account tracks refundable tax paid on eligible portfolio dividends your corporation has received from non-connected Canadian corporations, such as public company stocks. These dividends are subject to a refundable tax of 38.33%. When you pay eligible dividends to yourself, the corporation receives a refund of 38.33% of those dividends. Eligible dividends are taxed at a lower rate in the hands of shareholders due to an enhanced personal dividend tax credit.

Non-Eligible Refundable Dividend Tax on Hand (NERDTOH)

This notional account tracks refundable tax paid on other investment income, such as interest, taxable capital gains, or rental income from investment properties.  This income is subject to a refundable tax of 30.67%. Non-eligible dividends received from public companies also face a refundable tax of 38.33%. Like ERDTOH, when you pay non-eligible dividends to yourself, the corporation receives a refund of 38.33% of those dividends paid. While non-eligible dividends also receive a personal dividend tax credit, they’re taxed less favourably than eligible dividends.

If the shareholder of the dividend payer corporation is another private corporation, generally, the payer corporation is also eligible to receive a tax refund, and the recipient corporation is subject to paying a proportionate refundable tax. Federal Budget 2025 has proposed a change to this rule, which would suspend the refund received by a payer corporation in certain cases if the recipient corporation has a different fiscal year-end. These arrangements are more complex and beyond the scope of this article; we recommend discussing them with your tax advisor if you have a tiered corporate structure.

General Rate Income Pool (GRIP) 

The General Rate Income Pool is a notional corporate account that tracks two main sources: eligible portfolio dividends received from non-connected Canadian corporations (such as public company stocks), and business income taxed at the general corporate rate rather than the small business rate. 

GRIP is important because it determines the corporation’s ability to pay “eligible dividends” to you, which are taxed at lower personal tax rates than non-eligible dividends. When a corporation pays higher tax on its business income, GRIP increases , allowing future dividend payments that benefit from lower personal tax rates.

Capital Dividend Account (CDA)

The Capital Dividend Account allows your corporation to pay tax-free dividends to you as the shareholder. The CDA is credited with the non-taxable 50% portion of capital gains, certain life insurance proceeds, and capital dividends received from other corporations.

When your corporation pays you dividends from this notional account (which requires  corporate resolutions and a tax election form), you generally receive them tax-free. The balance needs to be large enough to justify the professional fees required for the necessary documentation.

Summary of Corporate Investment Income Concepts

Investment Income and the Small Business Deduction

If your corporation earns passive investment income, it’s important to understand how this can impact your access to the small business deduction (SBD). The SBD allows Canadian-controlled private corporations (CCPCs) to benefit from a lower tax rate on the first $500,000 of active business income each year, one of the key advantages of incorporation we discussed in Starting Strong: Benefits of Incorporating Your Business. However, this preferential treatment can be reduced if your corporation, and any associated corporations (those under common control) earn more than $50,000 in passive investment income in a given year.

Once passive investment income exceeds $50,000, your corporation’s access to the SBD is gradually reduced. For every dollar of investment income above this threshold, the amount of active business income eligible for the small business rate is reduced by $5. If your corporation earns $150,000 or more in passive investment income, the SBD is fully eliminated, and all active business income is taxed at the higher general corporate rate.

This “grind” on the small business deduction means that accumulating significant investment assets inside your corporation can increase your overall corporate tax bill on operating profits. As a result, it’s important to monitor your corporation’s investment income and consider strategies to manage or limit it, especially if maintaining access to the small business rate is a priority for your business.

A silver lining: While the grind can increase the corporate tax rate on active business income and reduce a tax deferral advantage, it’s not entirely negative. The higher tax paid on business income increases the corporation’s GRIP, which can later be used to pay eligible dividends to shareholders. These eligible dividends are taxed at lower rate personal rates, providing some future tax relief and partially offsetting the immediate impact.

Practical Strategies for Withdrawing Corporate Funds Tax Efficiently

Understanding these mechanics is only half the equation. The real value lies in applying them when you access your funds. The order in which you withdraw funds can make a significant difference to your after-tax wealth. Here’s an approach designed to maximize efficiency:  

*Note: Because both your personal and corporate tax situations can change from year to year, it’s important to review your withdrawal strategy annually with a tax advisor. Their guidance will help ensure you are optimizing your after-tax corporate withdrawals.*

1.  Capital Dividends

Withdraw capital dividends first, as these are received tax-free. Capital dividends are paid from the CDA, which accumulates tax-free amounts such as the non-taxable portion of capital gains. Since capital losses can reduce or eliminate your CDA, consider paying out capital dividends when the CDA has a positive balance and the amount justifies the professional fees required for the necessary resolutions and tax election.

2.  Shareholder Loan Balances

If you have a shareholder loan balance, meaning funds you previously advanced to the corporation or amounts credited to you but not yet withdrawn, you can withdraw up to the available balance tax-free. These withdrawals are considered a return of tax-paid funds, not income. Ensure all transactions are properly documented and do not exceed the available balance to avoid triggering personal tax.

3.  Salaries to You and Family Members

For those still actively operating and working in their business, consider paying yourself a salary and reasonable salaries to family members who work in the business. Salaries are deductible to the corporation, increase RRSP contribution room, and generate CPP benefits. CRA generally will not challenge the level of salary paid to active owner-managers, but salaries paid to family members must be reasonable for the services provided to avoid negative tax consequences. For more details on the salary versus dividend decision, refer to Compensation Crossroads: Salary, Dividends, or Both?

4.  Eligible Dividends (to Clear Out ERDTOH)

Pay eligible dividends next, focusing first on refunding or “clearing out” your corporation’s ERDTOH balance. These eligible dividends trigger a corporate tax refund and are taxed at lower personal tax rates. Depending on your personal income and province, the personal tax you pay may be significantly less than the corporate tax refunded, making this approach tax efficient. 

5.  Non-Eligible Dividends (to Clear Out NERDTOH)

Next, pay non-eligible dividends to clear out your corporation’s NERDTOH balance. While non-eligible dividends are taxed less favourably than eligible dividends, they still generate a corporate tax refund. Depending on your personal tax rate, this can be an efficient way to access corporate funds.

6.  Eligible Dividends (to the Extent of GRIP, No Refund)

Once all refundable tax balances have been cleared, you can pay additional eligible dividends up to the remaining GRIP balance. These dividends don’t generate a further dividend refund but are still taxed at a lower personal rate due to the enhanced dividend tax credit.

7.  Non-Eligible Dividends (No Refund)

Finally, if you need to withdraw more funds, you can pay non-eligible dividends beyond the NERDTOH balance. These dividends don’t generate a corporate tax refund and are taxed at higher personal rates, making them generally the least tax-efficient option.

Moving Forward with Confidence

Navigating the complexities of corporate investment income and withdrawal strategies requires specialized expertise and careful planning. Our Tax and Estate Planning team works closely with your tax advisor to develop strategies tailored to your unique circumstances and long-term wealth objectives. 

Please get in touch with your Mawer Investment Counsellor to discuss how we can support your corporate investment and withdrawal planning needs.

All tax information sourced from the Canada Revenue Agency as of November 2025