Dividend Types Under The Canadian Income Tax Act

It is known to many that having more income sources is better than being frugal. Over the years, financial literacy across the world has improved significantly. That is why it is no longer surprising to see increased cash inflows in the financial market. Stocks remain one of the most viable forms of investments. Despite the occasional price volatility, the benefits continue to outweigh the risk. 

It is important to identify where to put your investments and understand how they earn. These are in the form of cash dividends and stock dividends. Yet, tax is a life’s constant. Almost everything you have is subject to taxes. As such, you must know what types of dividends you will get and how much taxes to pay. 

Cash Dividends Vs. Stock Dividends

The frequency of dividend payouts depends on the reporting pattern of a company. Often, financial reports are released every quarter or half-year. Dividend distribution follows after a few weeks. In general, these are in the form of cash or shares. Whether a company is private or public, shareholders may receive dividends. The most common differences are the company ownership and the number of shares. 

Cash dividends are a more common form of dividends. Of course, these are subject to taxation under the Canadian Income Tax Act. Yet, taxes may change depending on the type of dividends. The dividend tax rate may range from 30% to 50%. Meanwhile, a company may not change the value of dividends. In general, it depends on the income and investing activities of the company. Dividend cuts may happen when net losses persist. In 2020, many companies in the hard-hit industries had dividend cuts or reductions. 

If the liquid cash is not enough, the company may opt to distribute stock dividends instead. These are done in percentages per existing shares. A shareholder with 100 shares will receive ten more shares if there is a 10% stock dividend. It can also happen in stock splits. Note that stock dividends are not taxable. But once the owner sells his shares, taxes will apply. 

Eligible Dividends Vs. Non-Eligible Dividends

The company deducts dividends from its net income of the company. In short, the corporate income tax is already paid before dividends. Since dividends are subject to taxes, it may lead to double taxation. The Canadian tax system avoids it using a dividend gross-up and a dividend tax mechanism. As such, investors pay lower taxes to account for the corporate income tax.

Dividend taxes in Canada vary according to dividend types. These are either eligible or non-eligible dividends. The company must determine if it qualifies for the small business deduction. Doing so will lead to adjustments to dividend gross-ups and dividend tax credit. From there, it may account for the appropriate corporate income tax. 

Eligible Dividends

Under Section 89(14) of the Canadian Income Tax Act, eligible dividends are designated. In essence, eligible dividends come from Canadian resident corporations to Canadian residents. The company can do it in writing to inform each recipient that dividends are eligible. It will allow the investors to enjoy the advantages of eligible dividends. For public companies, announcements are on its website and press releases. In general, these companies distribute eligible dividends. They can do so as long as they don’t have a low-income rate pool (LRIP). 

With regards to taxes, some companies do not qualify for small business deductions. They will have to pay higher corporate income tax and distribute eligible dividends. The corporate income tax in Ontario is 25%. In turn, dividend taxes are set at preferential rates. On average, the Canada dividend tax rate is 38%, ranging from 28% to 42%. It depends on the province and in which bracket the investor belongs. Also, investors may receive higher Dividend Tax Credits (DTC). 

Non-Eligible Dividends

A Canadian Private Controlled Corporation (CCPC) often distributes non-eligible dividends to the investors. It is a company qualified for small business deductions. Given this, preferential tax treatments are rarely given to it. But, it has a lower corporate income tax of 15%. 

CPCCs can pay eligible dividends if the amount does not exceed its General Rate Income Pool (GRIP). But in most cases, corporate income tax remains low, and dividends remain non-eligible. As such, investors face less favorable dividend tax treatments. On average, the dividend tax burden is 45%, ranging from 36% to 47%.

Dividend Tax Credit and Gross-Up 

The dividend tax credit and gross-up demonstrate the actual benefit of eligible dividends. Since both profits and dividends are taxable, gross-ups help prevent double taxation. The dividend tax is computed after the dividend tax credit. The tax credit is 15.0198% for eligible dividends and 9.0301% for non-eligible dividends. Meanwhile, their gross-up is 38% and 15%, respectively. As such, the applicable dividend tax is more favorable for eligible dividends.

For example, Mr. White receives eligible dividends of $100 with an effective tax rate of 25%. His taxable dividend is grossed up first by 38%, increasing to $138. Supposedly, his dividend tax is $34.5 ($138*25%). But with a dividend tax credit of $20.74 (138*15.0198%), his tax will decrease to $13.76 ($34.5-$20.74). 

If Mr. White receives non-eligible dividends, things will be different. Suppose he has the same dividends and effective tax rate. His grossed-up dividends will be $115, while dividend tax will decrease to $28.75 ($115*0.25). But, his dividend tax credit will be lower at $10.67 ($115*0.09301). Hence, his dividend tax will be $18.08 ($28.75-$10.67).

If you have issues regarding your taxes, schedule an appointment with the experts from Rotfleisch & Samulovitch P.C.

Contact a Toronto Tax Lawyer Today

The type of dividend depends on the company. Eligible dividends and non-eligible dividends have different tax computations. Yet, eligible dividends are not always better than non-eligible dividends. 

The thing is, dividends vary from company to company. Check first if the company has adequate net income. You may also check other financial accounts to assess viability and sustainability. This will depend on the industry of the company. 

You have to make sure you can figure out how dividends are distributed and taxed. If you want to understand the computation better, you may talk with a tax professional. If you are in Toronto, reach out and seek assistance from a Taxpage’s tax lawyer for further information.

About the Author

---

David J. Rotfleisch

David J. Rotfleisch, a leading Canadian tax lawyer, is not only a certified specialist in taxation but also a chartered professional accountant. Most recently, David is a pioneer in Canadian crypto taxation.

As of April 2020, he was one of 12 Ontario Certified Specialists In Taxation™.

Learn more about David J. Rotfleisch