A dividend typically represents business or investment profits earned and distributed by a corporation to its shareholders. A dividend from a corporation is usually reported on a T5 slip to be included in your personal taxes.
Assuming that a dividend is received from a corporation resident in Canada, it will be taxed at a lower rate than other types of income, such as employment or interest income. The reason is that the income earned by the corporation and used to pay the dividend has already been subject to corporate tax. Thus, there is a mechanism designed to provide credit for taxes already paid at the corporate level.
Dividends paid by Canadian corporations are classified as either “eligible,” “non-eligible”.
An eligible dividend is a taxable dividend that is paid by a Canadian resident corporation, received by a Canadian resident individual, and designated by a corporation as an eligible dividend under section 89(14) of the Income Tax Act. Eligible dividends are generally received from public corporations (who do not receive the small business deduction) or private corporations with high earnings (net income over the $500,000 small business deduction). Those types of corporations pay corporate tax at higher rates than small businesses. A portion of income that is taxed at the higher corporate tax rate flows into a corporation’s general rate income pool (GRIP) balance and accumulates. GRIP represents the after-tax amount of income that has been subject to the higher corporate tax rate.
Eligible dividends are “grossed up” to reflect corporate income earned, and then provided with an enhanced dividend tax credit which reflects the higher rate of corporate tax that has been paid. Eligible dividends are therefore taxed at a lower rate when received by individuals than non-eligible dividends. This is what causes eligible dividends to be taxed more favorably on your personal taxes compared to non-eligible dividends.
Non-eligible dividends, also known as regular, ordinary, or small business dividends, dividends are generally received from Canadian private corporations that have paid the lower tax rate on the first 0,000 of income. Non-eligible dividends are also grossed-up to reflect pre-tax corporate income and then provided with a lower dividend tax credit since the corporation has paid less corporate tax. However, the percentages used are different to reflect corporate tax paid at a lesser rate. Therefore no income is taxed at the higher corporate rate and no GRIP pool is created, meaning eligible dividends are not able to be issued.
Note – The dividend tax credit applies only to Canadian resident individuals receiving taxable dividends from Canadian resident corporations. It does not apply to dividends you receive from foreign corporations, as it is not considered appropriate for the Canadian government to provide you with a credit for foreign corporate tax paid by the foreign corporation. However, you will get a foreign tax credit for the foreign tax that you pay personally on the dividend (often a 15% withholding tax, but the rate depends on the country and the provisions of Canada’s tax treaty with that country if there is one).
As you can see eligible and non-eligible dividends are treated differently. It’s important to know the differences between them and how they can impact the amount of tax you pay so you can plan accordingly with your tax accountant.
Our experienced and professional team at Filing Taxes is here to set you on the right path considering your personal business situation. Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.