In: Accounting
Which of the following does not provide an accurate description of refundable taxes?
A. The basic concept of refundable taxes is that a portion of the corporate tax paid on investment income is refunded to the corporation when the income is distributed to shareholders in the form of dividends.
B. One purpose of refundable taxes is to keep corporate tax rates high to discourage accumulation of investment income in a corporation.
C. The only purpose for refundable taxes is to create perfect integration in the Canadian tax system.
D. There are three different components of tax that can be refunded on the payment of dividends: Refundable portion of Part I tax, Additional Refundable Tax on Investment Income, and Part IV tax.
C. The basic concept of refundable tax is not to create a perfect integration in the Canadian tax system. Hence it does not provide an accurate description of refundable taxes.
Canada tax system is built on the concept of integration between the corporations and their shareholders. In other words, the shareholders earning investment income in a corporation should pay the same amount of tax on that investment income as they would otherwise pay if such income was earned personally. The integration is carried out through the concept refundable tax mechanism whereby the Refundable Dividend Tax On Hand (RDTOH) is applied to income earned from passive investments held in private corporation.
The income earned by the Corporation such as interest, rents, royalties, capital gains and dividends from foreign investments that are called passive investment income and are subject to higher tax rate than active business income. A portion of that higher tax is refunded by the Federal Government to the corporation when it distributes taxable dividends to its shareholders. Such passive investment income are subjected to higher tax rate up-front to reduce the incentive of retaining this income in a private corporation.
There are generally three components to the RDTOH account in a corporation. The first arises from “Part 1 refundable tax,” the second is the additional refundable tax on investment and the third from dividends received from other corporations also known as Part IV tax.