Tax rates on noneligible dividends are set to rise in 2018 for Canadians. These tax increases will undoubtedly have an impact on individual investors and certain corporations. As an accountant, it’s critical you understand how to properly deal with these increases for your clients.
What Is a Noneligible Dividend?
Noneligible dividends are any dividends 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. Noneligible dividends also include dividends paid out of income that’s eligible for the federal small business income tax rate.
Finance Minister Bill Morneau released a Notice of Ways and Means Motion to Amend the Canadian Income Tax Act in October 2017, which included a reduction of corporate income taxes that applied to small business earnings. The following month, Ontario’s Finance Minister Charles Sousa introduced legislation that also included a reduction to taxes based on small business earnings and a proposed increase in personal tax rates on noneligible dividends. The result of these pieces of legislation is that federal and Ontario’s tax rates on small business earnings each decrease in 2018. The federal rate goes from 10.5 percent in 2017 to 10 percent in 2018, and the Ontario rate drops from 4.5 percent in 2017 to 3.5 percent in 2018.
The reason the tax rate on noneligible dividends is increasing is to maintain the integrative nature of the personal and corporate tax structures. This attempts to ensure that the total amount of taxes at the personal and corporate level remain roughly the same regardless if the income is earned as an individual or through a corporation.
Concerns for Canadian-Controlled Private Corporations
There is concern that one of the five types of Canadian corporations, Canadian-controlled private corporations (CCPCs), will see an overall tax increase because of the overall legislative changes. Cases may exist where an individual shareholder in a CCPC has significant accumulated retained earnings that were already taxed at higher historical rates. These earnings, once distributed as dividends, will then be subject to higher personal tax rates. Since there are no clauses in the legislation to allow for grandfathering of lower rates on these distributions, the extra taxation is causing some alarm.
Combined Effective Rates on Noneligible Dividends
The combined effective federal and provincial/territorial tax rate on noneligible dividends distributed from CCPCs to individuals varies quite a bit. Assuming the individual falls into the top marginal tax rate, the range across all territories was 48.25 percent to 59.7 percent in 2017. In 2018, this range increases to 48.47 percent to 59.98 percent. For 2019 and 2020, the range further increases to 49.14 percent to 60.69 percent. As for the increase in 2018, Quebec remains approximately flat, with only a 0.02 percent increase for the year. British Columbia sees the largest increase for the year at 2.81 percent.
Overall, personal tax rates on noneligible dividends are increasing. Individuals in the top marginal tax rate will see an average increase in their tax rate of 1 percent from 2017 to 2019. Beyond personally paying more taxes on noneligible dividends, it will be less tax-efficient to earn investment income from a CCPC that faces increased taxes on noneligible dividends when distributing earnings to shareholders. Accountants should take extra care to ensure they are keeping appropriate records of noneligible dividends for clients and providing correct advice on current and future taxes.