Intercorporate Dividend Rules Canada — Section 112 & 113 (2026)

Reviewed by Bader A. Chowdry, CPA, CA, LPA on July 4, 2026

How do intercorporate dividends actually work in 2026?

When one Canadian corporation pays a dividend to another, the recipient includes the dividend in income and then deducts it under ITA s.112(1). The net effect is that dividends generally flow between taxable Canadian corporations at a $0 corporate tax cost. This is what lets a holding company (Holdco) receive profits from an operating company (Opco) without a second layer of tax — the foundation of most owner-manager group structures we build at Insight Accounting CPA.

When does Part IV tax apply to a dividend my corporation receives?

Part IV tax under ITA s.186(1) applies at 38⅓% (38.33%) when a private corporation receives a portfolio dividend, or a dividend from a corporation that is not connected with it. For a connected corporation — one you own more than 10% of by votes and value — Part IV tax only applies to the extent the payer receives a dividend refund. The tax is refundable, so it is a timing cost, not a permanent one.

What is the difference between connected and non-connected corporations?

Under ITA s.186(4), a payer is connected with the recipient if the recipient controls the payer, or owns shares carrying more than 10% of the votes and more than 10% of the fair market value. Connection matters because it changes the Part IV tax result: dividends from connected corporations are usually Part IV tax-free, while dividends from non-connected (portfolio) holdings attract the full 38.33% refundable tax.

Section 112 — the deduction for Canadian intercorporate dividends

ITA s.112(1) allows a corporation resident in Canada to deduct taxable dividends received from a taxable Canadian corporation (and certain other Canadian corporations it controls) in computing taxable income. The text of section 112 on the federal Justice Laws website confirms the mechanism. The CRA’s Income Tax Folio S3-F2-C2, Taxable Dividends from Corporations Resident in Canada is the CRA’s administrative guide to how the deduction is applied. The result: dividends move up a corporate chain without a second corporate tax hit, provided the anti-avoidance rules below are respected.

Section 113 — dividends from foreign affiliates

Where the dividend comes from a foreign affiliate rather than a Canadian corporation, ITA s.113 governs. It provides deductions based on the affiliate’s surplus pools: exempt surplus (active business income earned in a treaty or designated country, generally deductible in full), taxable surplus (deductible with an offsetting gross-up and underlying/withholding foreign tax factor), and pre-acquisition surplus (which reduces the adjusted cost base of the affiliate shares). For Ontario private groups with US or offshore holdings, s.113 planning turns on which surplus account a distribution is drawn from. These rules were not amended in Budget 2025 and continue to apply for 2026.

Section 55(2) — the anti-avoidance trap on the tax-free dividend

ITA s.55(2) is the rule that can turn an otherwise tax-free intercorporate dividend into a capital gain. It targets “capital gains stripping” — converting a gain that would arise on a share sale into a tax-free dividend. Where a dividend exceeds the “safe income” attributable to the shares, and one of the purpose tests is met, s.55(2) recharacterizes the excess as a gain. Because the 2015 amendments broadened the purpose tests, s.55(2) now needs to be considered on almost every non-routine intercorporate dividend, not just obvious surplus-stripping plans.

Safe income — the number you must track

“Safe income” is the tax community’s shorthand for the amount in paragraph 55(2.1)(c): income earned or realized after 1971 that can reasonably be considered to contribute to the capital gain on the shares. A dividend paid out of safe income is protected from s.55(2). The practical discipline is a running safe-income on hand (SIOH) calculation per share class, updated at each transaction. The CRA has issued extensive administrative commentary on safe income; where a dividend is at risk of exceeding SIOH, a safe-income determination time and a documented calculation are essential before the dividend is declared.

Part IV tax, RDTOH and the refund mechanism

When Part IV tax applies, the 38⅓% paid is added to the recipient’s Refundable Dividend Tax on Hand (RDTOH). Since 2019, RDTOH is split into two pools: eligible RDTOH (ERDTOH) and non-eligible RDTOH (NERDTOH). When the corporation later pays a taxable dividend to its own shareholders, it recovers a dividend refund equal to the lesser of 38⅓% of the dividends paid and the relevant RDTOH balance — eligible dividends draw first on ERDTOH, non-eligible dividends on NERDTOH. This preserves integration: investment income taxed inside a corporation is not permanently over- or under-taxed compared with earning it personally. The CRA sets out the RDTOH and dividend-refund calculation in its T2 Corporation Income Tax Guide, Chapter 6.

Case study: Mississauga family medical practice group

A Mississauga physician operated through a medical professional corporation (Opco) and wanted to move retained after-tax earnings into a holding company for creditor protection and investment. We inserted a Holdco that owned the Opco, with the Opco paying up an annual dividend. Because Holdco owned 100% of Opco (well over the 10% connected threshold), the dividend was received free of Part IV tax and deducted under s.112(1). We calculated safe income on hand before each dividend so the payments stayed inside the s.55(2) safe harbour, and tracked the ERDTOH/NERDTOH pools so the family’s eventual personal dividends triggered the maximum dividend refund. The structure is a routine one — but the safe-income and Part IV mechanics are exactly where do-it-yourself plans go wrong.

What clients ask us most about intercorporate dividends?

The most common questions are whether dividends between their companies are really tax-free (usually yes under s.112, subject to s.55(2)), whether they owe Part IV tax (only on non-connected or portfolio dividends, or where the payer got a refund), and how to avoid an unexpected capital gain from s.55(2). The honest answer is that the deduction is simple; the anti-avoidance and refundable-tax overlay is where professional judgment earns its keep.

Why Bader’s CPA, CA and LPA combination matters here

Intercorporate dividend planning sits at the intersection of tax law and assurance. As a CPA, CA and Licensed Public Accountant (LPA), Bader A. Chowdry can both design the Holdco/Opco structure and stand behind the financial statements and safe-income schedules that support it — including where a lender, regulator or purchaser later requires audited or reviewed figures. That combination is uncommon among Ontario firms serving owner-managed groups.

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Frequently asked questions

Are dividends between my two corporations really tax-free?

Generally yes. Under ITA s.112(1) a taxable Canadian corporation deducts dividends received from another taxable Canadian corporation, so there is no second layer of corporate tax. The two overlays to watch are Part IV tax (on non-connected or portfolio dividends) and s.55(2) (which can convert an excess-over-safe-income dividend into a capital gain).

What is the Part IV tax rate for 2026?

Part IV tax is levied at 38⅓% (38.33%) of the dividend. It is fully refundable through the RDTOH mechanism when the corporation later pays a taxable dividend to its shareholders, so it functions as a prepayment rather than a permanent tax.

How do I know if my corporations are “connected”?

Under ITA s.186(4), corporations are connected if one controls the other, or the recipient owns shares carrying more than 10% of the votes and more than 10% of the value of the payer. Dividends from connected corporations are usually free of Part IV tax.

What is safe income and why does it matter?

Safe income (paragraph 55(2.1)(c)) is the after-tax retained earnings that can reasonably be considered to contribute to the accrued gain on your shares. A dividend paid out of safe income is protected from s.55(2); a dividend that exceeds it can be recharacterized as a capital gain. Tracking safe income on hand before each intercorporate dividend is the key protective step.

This article is published by Insight Accounting CPA Professional Corporation for general educational purposes only and does not constitute professional accounting, tax, or legal advice. Tax rules change and their application depends on your specific facts; you should consult a qualified advisor before acting. About the Author: Bader A. Chowdry, CPA, CA, LPA is the principal of Insight Accounting CPA Professional Corporation. Public accounting services in Ontario are provided under a Licensed Public Accountant (LPA) licence issued under the Public Accounting Act, 2004.