Tax rates on non-eligible dividends were on the rise in 2018, a trend that’s expected to continue through 2020. These tax increases undoubtedly have an impact on individual investors and certain corporations. As an accountant, you should understand how to apply these increases properly for your clients and your firm.
What Is a Non-Eligible Dividend?
Non-eligible dividends are disbursements issued by a public or private corporation in Canada that aren’t eligible for the enhanced dividend tax credit. These dividends are also called regular, ordinary, or small-business dividends. Non-eligible dividends also include dividends paid out of income that’s eligible for the federal small-business income tax rate.
Background on Tax Rate Changes
In October of 2017, Finance Minister Bill Morneau released a motion to amend the Canadian Income Tax Act, which included a reduction of corporate income taxes that applied to earnings from small businesses. The following month, Ontario’s Finance Minister Charles Sousa introduced legislation that also included a reduction to taxes based on small-business earnings, as well as a proposed increase in personal tax rates on non-eligible dividends. The result of this legislation was that federal tax rates on small-business earnings both decreased in 2018. The federal rate dropped from 10.5% to 10% in 2018, and the Ontario rate dropped from 4.5% to 3.5% in 2018.
The tax rate on non-eligible dividends was increased to help maintain the integrity of personal and corporate tax structures. In other words, personal and corporate taxes remain roughly the same regardless if the income earned was by an employee or by a CEO.
Concerns for Canadian-Controlled Private Corporations
Five different types of corporations can be privately controlled in Canada. There was concern that one of these types, Canadian-controlled private corporations (CCPCs), would see an overall tax increase because of these legislative changes. For instance, if an individual shareholder in a CCPC has a large accumulation of retained earnings that have already been taxed, then these earnings, once distributed as dividends, are subject to an even higher personal tax rate. To date, there are no clauses in the legislation that allow for grandfathering the lower rates on these distributions. So, the extra taxation is causing alarm.
Combined Effective Rates on Non-Eligible Dividends
The combined effective federal and provincial/territorial tax rate on non-eligible dividends distributed from CCPCs to individuals varies quite a bit, and you should do some research to see how the tax rates affect you and your clients. Overall, personal tax rates on non-eligible dividends are increasing. Individuals in the top marginal tax rate are going to see an average increase in their tax rate of 1% through 2019. Beyond setting more money aside to outrun an increasing tax rate, you should educate your clients on non-eligible dividends, and the fact that it’s less tax-efficient to earn investment income from a CCPC that faces increased taxes at distribution time.
Accountants should take extra care to ensure they’re keeping appropriate records of non-eligible dividends for clients and providing correct advice on current and future taxes. Accelerate your year-end adjustment process and start saving time on corporate returns with QuickBooks Online Accountant. Sign up for free.