The Dividend Tax Credit

Editor's Note: from http://www.professionalreferrals.ca/

The Dividend Tax Credit provides preferential tax treatment for individuals with dividend income from Canadian resident corporations.

The Dividend Tax Credit provides preferential tax treatment of dividend income for stockholders of Canadian resident corporations.

Taxable dividends received by Canadian resident individuals from Canadian resident corporations are taxed at lower rates than other forms of income.

Dividends are included in income in the year they are received. The preferential tax treatment to individuals results from the so-called dividend tax credit.

Eligibility

A stock dividend issued by a Canadian resident corporation is eligible for the dividend tax credit, the amount of the dividend normally reflected in a T5 slip issued by the corporation. There is no dividend tax credit eligibility for dividends received from non-Canadian (foreign) corporations. To avoid double taxation, Canada allows a foreign tax credit of up to 15% of the amount of the dividend, for foreign tax paid on the dividend.

The dividend tax credit generally works as follows:

• First a dividend received from a Canadian corporation is “grossed-up” by 25%, meaning that the recipient adds an additional 25% on top of the dividend received as income.

• The dividend tax credit is calculated as 2/3rds of the 25% gross-up; put another way, it equals 162/3% of the actual dividend received. See subsections 82(1)ITA reference 82(1) and 121ITA reference 121.

• The regular federal tax payable on that amount is reduced by the amount of the dividend tax credit.

The provincial tax, which is based on the amount of federal tax, is reduced accordingly.

The effect of the dividend tax credit is to reduce dividend income at the highest marginal rate to 14% to 17% lower than the highest marginal rate for ordinary income, depending on the province.

The dividend tax credit allows approximately $22,000 of dividend income (depending on the province) to be received free of tax by an individual who has no other source of income to declare. This can make dividend income splitting among family members very appealing.

Capital Dividends

Capital dividends issued by private corporations are received free of tax. Capital dividends may be paid from the corporation’s capital dividend account, which includes the non-taxable portion of any of the corporation’s capital gains, and net life insurance proceeds received by the corporation in consequence of the death of any person (typically, a shareholder of the corporation).

Non-residents

Non-residents stockholders receiving dividend income from Canadian resident corporations are subject to a 25% withholding tax. The tax is reduced under most tax treaties to 15%. It is reduced further to either five per cent or 10%, depending on the treaty, in cases where the recipient is a corporation that owns a significant interest in the Canadian corporation.