Understanding Dividends and their Tax Implications in Canada
A dividend is a payment made by a business or investment corporation to its shareholders. In Canada, dividends from corporations are subject to lower tax rates compared to other forms of income, such as wages or interest. This is because the corporation has already paid taxes on the earnings used to distribute eligible and non-eligible dividends. As a result, double taxation is avoided, and there is an opportunity to claim a credit for the corporate taxes already paid.
The tax system aims to ensure that individuals pay a similar amount of tax whether they earn income directly or through a corporation. Therefore, the profits generated by a business should be distributed to the shareholders as dividends. Without providing a credit for corporate taxes, the additional tax burden on dividends would make it more challenging for individuals to invest in both public and private companies.
When a Canadian corporation pays out a dividend, it can be categorized as an “eligible,” “non-eligible,” or “capital” dividend. The tax implications and rates associated with each type of dividend reflect how the corporation is taxed on its own income and how much tax would be paid if the same income were earned by an individual.
In many cases, Canadian-owned private corporations (CCPCs) pay lower taxes on their first $500,000 of income and higher taxes on subsequent income (20 percent in Ontario for 2017). Consequently, it is possible for a company with higher-taxed income to pay an eligible dividend. This means that small business income taxed at a lower rate may not be distributed as a dividend.
Understanding the taxation of dividends is crucial for shareholders and investors in Canada. By considering the tax implications, individuals can make informed decisions regarding their investments and optimize their overall tax situation.
Note: Tax laws and regulations may change over time, so it’s essential to consult with a tax professional or refer to the latest information from the Canada Revenue Agency (CRA) for accurate and up-to-date guidance.
Understanding Eligible Dividends in Canada
An eligible dividend, as defined in section 89(14) of the Income Tax Act, refers to a taxable dividend paid by a Canadian resident corporation, received by a Canadian resident individual, and designated by the corporation as an eligible dividend under this section.
Public corporations that do not qualify for the small business deduction or private corporations with significant net income (exceeding the $500,000 small business deduction) are more likely to distribute eligible dividends. These types of businesses pay higher corporate taxes compared to small businesses.
When a portion of a company’s income is subject to the higher corporate tax rate, it is allocated to the company’s general rate income pool (GRIP) balance, which grows over time. Essentially, GRIP represents the income that has been taxed at a higher rate due to its source from a business.
All eligible dividends are “grossed up” to reflect the total income generated by the company. Since the company paid taxes at a higher corporate tax rate, a larger credit is granted for eligible dividends. Individuals receiving eligible dividends are subject to a lower tax rate compared to those receiving non-eligible dividends. When it comes to taxing one’s own income, eligible dividends are treated more favorably than non-eligible dividends.
It is important to note that the taxation of dividends can be complex and subject to various factors. Seeking guidance from a tax professional or referring to the latest information from the Canada Revenue Agency (CRA) is recommended to fully understand the specific tax implications associated with eligible dividends.
Please keep in mind that tax laws and regulations may change, so it is essential to stay updated with the latest information from the CRA or consult a qualified professional for personalized advice.
Understanding Ineligible Dividends in Canada
Ineligible dividends primarily originate from Canadian private corporations that have paid the lower tax rate on the initial $3,000 of income. These dividends are commonly referred to as “regular,” “normal,” or simply “dividends” from small companies.
When dividends that are not eligible are grossed up to represent pre-tax corporate income, a reduced dividend tax credit is applied. However, the percentages used to calculate the amount of corporate tax paid differ because the tax rate is lower.
The reason ineligible dividends cannot be paid out is that no income is taxed at the higher corporate tax rate, and there is no creation of a general rate income pool (GRIP).
If you are a Canadian resident receiving taxable dividends from a Canadian company, you may be eligible for a tax credit on that income. However, this credit does not apply to dividends received from foreign corporations since the Canadian government does not consider it appropriate to provide a credit for foreign corporate taxes paid to the foreign entity.
The taxation of eligible and non-eligible dividends depends on the country of residence. You will receive a credit for the 15% withholding tax you paid on your own, which is known as a “foreign tax credit,” when the dividend is taxed in the country where you reside.
It’s important to note that dividend taxation can be complex, and individual circumstances may vary. Seeking advice from a tax professional or consulting the latest information from the Canada Revenue Agency (CRA) is recommended to fully understand the specific tax implications associated with ineligible dividends.
Please bear in mind that tax laws and regulations are subject to change, so staying updated with the latest information from the CRA or consulting a qualified professional is crucial for accurate and personalized advice.
Different Forms of Dividends
Dividends can take various forms, depending on how a corporation chooses to distribute its shareholders’ funds. When a corporation declares a dividend, the directors announce that the money will be distributed to the shareholders. While cash dividends are common, dividends can also be issued in other forms such as stock, property, or debts.
A stock dividend occurs when a corporation rewards its shareholders by giving them additional shares of stock. To determine the value of a stock dividend, the fair market value of the stock is added to the dividend.
On the other hand, a property dividend does not involve cash. It typically refers to distributions of assets like equipment, inventory, real estate, art, or jewelry.
For individuals receiving dividends, the value of the dividend is equivalent to its fair market value. However, for the corporation, distributing property as a dividend triggers a taxable event. The corporation will realize gains or losses based on the current fair market value of the property minus its adjusted cost base.
In certain cases, a corporation may issue dividends in the form of notes payable. This means the corporation promises to repay the dividends at a later date, essentially creating a debt obligation. This type of dividend can serve various purposes in business planning and corporate reorganizations.
The note payable may or may not accrue interest, depending on the specific terms. It’s important to note that the note payable is considered income for the recipient, who must report its value on their Canadian income tax return for that year.
It’s worth consulting a tax professional or referring to the Canada Revenue Agency (CRA) guidelines for accurate information on reporting and taxation of dividends in different forms. As tax regulations can change over time, staying up to date with the latest guidelines is essential for proper tax planning and compliance.