Dividend Taxation
The system in place to tax Canadian dividend income is designed to achieve “integration.” The intent of integration is to ensure that the combined total personal and corporate tax imposed on different types of income received directly or from a corporation is roughly equal. In other words, integration tries to ensure that there is no tax advantage to be gained by having income earned through a corporation.
There are two types of dividends: eligible and ineligible. Eligible dividends are those paid from public companies, along with dividends paid by private companies where the dividend arises from income taxed at regular rates (i.e., without any tax preferences). Ineligible dividends are dividends paid by a private company that arose from income that received some type of special tax preference (such as the small business deduction).
Eligible dividends are grossed up to 138% of actual value, and ineligible dividends are grossed up to 118%, and tax is calculated on these grossed-up amounts.
Dividends also generate a dividend tax credit. The dividend tax credit is intended to approximate the corporation’s income tax paid. The dividend tax credit reduces the shareholder’s income taxes otherwise payable and leaves the shareholder with a net effective income tax liability on dividends received.
The following table shows the dividend tax credit for the federal and each provincial government for eligible and ineligible dividends.
The table in Figure 1 highlights the significant variations in rates across the provinces. Some of the variation reflects the different corporate tax rates and some of the variation is about each province’s need for tax revenue.
Let’s look at two examples that compare the tax consequences of dividend income, assuming the dividend is taxed at the top marginal rate.
2014
| Dividend Gross-Up | 38% | 18% | ||
|---|---|---|---|---|
| Tax credit on taxable eligible dividend (%) |
Top Effective tax rate on eligible dividends (%) |
Tax credit on taxable ineligible dividend (%) |
Top Effective tax rate on ineligible dividends (%) |
|
| Federal | 15.02 | 11.02 | ||
| Alberta | 10.00 | 19.29 | 3.10 | 29.36 |
| British Columbia | 10.00 | 28.68 | 2.59 | 37.99 |
| Manitoba | 8.00 | 32.26 | .83 | 40.77 |
| New Brunswick | 12.00 | 27.35 | 5.30 | 36.02 |
| Newfoundland and Labrador | 5.40 | 30.20 | 4.10 | 32.08 |
| Nova Scotia | 8.85 | 36.06 | 5.87 | 39.07 |
| Ontario | 10.00 | 33.82 | 4.50 | 40.13 |
| Prince Edward Island | 10.50 | 28.71 | 3.20 | 38.74 |
| Quebec | 11.90 | 35.22 | 7.05 | 39.78 |
| Saskatchewan | 11.00 | 24.81 | 3.40 | 34.91 |
Figure 2 starts with a $10,000 eligible dividend received by two individuals – one in Alberta and one in Manitoba. The net combined federal and provincial tax payable differs significantly – $1,929 paid in Alberta on the receipt of the $10,000 dividend, whereas the liability increases to $3,226 in Manitoba. This differential is highlighted through the calculation of the effective tax rate. The individual living in Alberta pays an effective tax rate of 19.29% compared with the individual living in Manitoba where the rate jumps to 32.26%.
Figure 2 – Eligible Dividend Comparison
| Alberta | Manitoba | |
|---|---|---|
| Eligible Dividend | $10,000 | $10,000 |
| Gross Up | 38% | 38% |
| Taxable Dividend | $13,800 | $13,800 |
| Top Marginal Tax Rate | 39.00% | 46.40% |
| Taxes Payable | $5,382 | $6,403 |
| Federal Dividend Tax Credit Rate | 15.02% | 15.02% |
| Provincial Dividend Tax Credit Rate | 10.00% | 8.00% |
| Provincial Dividend Tax Credit Rate | 10.00% | 8.00% |
| Total Dividend Tax Credit | $3,453 | $3,177 |
| Net Taxes Payable | $1,929 | $3,226 |
| Effective Tax Rate | 19.29% | 32.26% |
Figure 3 depicts the outcome of a $10,000 ineligible dividend received by individuals in British Columbia and Prince Edward Island. The total taxes payable on the divi- dend are quite comparable at $3,798 in B.C. and $3,912 in PEI. As you might expect, the effective tax rate is also quite similar at 37.98% in B.C. and 38.74 in PEI.
Figure 3 – Ineligible Dividend Comparison
| B.C. | PIE | |
|---|---|---|
| Ineligible Dividend | $10,000 | $10,000 |
| Gross Up | 18% | 18% |
| Taxable Dividend | $11,800 | $11,800 |
| Top Marginal Tax Rate | 45.80% | 47.37% |
| Taxes Payable | $5,404 | $5,590 |
| Federal Dividend Tax Credit Rate | 11.02% | 11.02% |
| Provincial Dividend Tax Credit Rate | 2.59% | 3.52%* |
| Total Dividend Tax Credit | $1,606 | $1,716 |
| Net Taxes Payable | $3,798 | $3,874 |
| Effective Tax Rate | 37.98% | 38.74% |
* PEI has a surtax that increases the value of their dividend tax credit.
The federal and provincial governments are constantly tinkering with their dividend tax credit rates. In some situations, a taxpayer may be in a position to delay or accelerate dividends depending on which direction the change is heading.
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Copywrite ISSN 0382-7038
Contributors to this edition:
James W. Kraft, cpa, ca, mtax, tep, cfp, clu, ch.f.c.
Deborah Kraft, mtax, tep, cfp, clu, ch.f.c.
