Taxation of Dividend Income

While not quite as common as interest income, income in the form of dividends is received each year by millions of Canadian taxpayers. Such income simply represents a share of the after-tax profits of a corporation distributed to the corporation’s shareholders. Dividend income can, in many cases, receive preferential tax treatment. Like regular interest payments, dividends are reported on the tax return for the year in which they are received and will be summarized on a T5 provided to the shareholder by the company issuing the dividend. Shareholders may hold either common or preferred shares of the company, and dividends declared on either kind of shares are treated identically for tax purposes.

What does differ, however, is the treatment of dividends received from Canadian, as distinct from non-Canadian, companies. Dividends received from non-Canadian companies (foreign-source dividends) are simply converted by the shareholder recipient into Canadian dollars (at the exchange rate in effect when the dividend was received) and that Canadian dollar amount is reported on the shareholder’s tax return for the year at line 121.

Where the dividend has been issued by a Canadian company, much different and better tax treatment results, through a mechanism known as the “dividend gross-up and tax credit”. Although the details of that credit can be convoluted, its purpose is straightforward. Corporations pay tax on income as it is earned. When such income is paid out to the corporation’s shareholders in the form of dividends, the money paid out is after-tax income — that is, income on which tax has already been paid by the corporation. The dividend gross-up and tax credit is the means by which our tax system tries to ensure that credit is given at the shareholder level for tax already paid by the corporation on income subsequently distributed as shareholder dividends. Ideally, the total amount of tax paid on income from which a corporate dividend is paid should be same as that which would have been paid by the shareholder if the income had been earned directly.

Complicating matters further, the calculation of the dividend tax credit and gross-up will differ, depending on the rate of tax paid by the corporation on the distributed income. Dividends (known as eligible dividends) paid from income taxed at the higher “general” corporate rate get greater credit at the shareholder level than those (ineligible dividends) paid from income which was taxed to the corporation at the lower small business rate.

Fortunately for the shareholder/taxpayer, the details of what constitutes an eligible as opposed to an ineligible dividend and the intricacies of calculating the dividend tax credit in each case are largely a matter of concern only to professional tax practitioners and the tax authorities. For the shareholder, all of the necessary characterizations and computations have been done, and the required information summarized on a T5 information slip. The income tax return guide provided by the CRA will then guide the taxpayer on how to transfer the information found on the T5 to the tax return form.

Dividend tax rates

Because of differences in provincial tax rates, there is a great deal of variation in the tax rate applied to dividends. However, for taxpayers in the highest income bracket (i.e., those having taxable income of about $136,270 or more in 2014), it is generally the case that eligible dividends will be taxed at between 19% and 35%, while ineligible dividends will be taxed at rates ranging from 29% to 41%.

The articles posted here provide information of a general nature. These articles should not be considered specific advice; as each vistor’s personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in these articles.

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