Taxation of Dividend Income

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.