Canada’s dividend tax credit can be a significant money saver for many people, so it’s important to keep your clients informed about their eligibility for it. Here’s a refresher on the dividend tax credit, who’s eligible to receive it, and how it can benefit them.
The Dividend Tax Credit
Canada’s dividend tax credit is the credit individuals can apply against taxes they owe on dividends paid to them by Canadian companies. The dividend tax credit doesn’t apply to dividends paid by foreign corporations. The primary purpose behind dividend tax credits is to avoid double taxation since dividends are paid to shareholders with the profits that a company has already paid taxes on. Basically, the dividend tax credit gives your client “credit” for the taxes the company already paid.
Factors That Affect Your Dividend Tax Credit
The dividend tax credit varies between eligible dividends and ineligible dividends. Most dividends are eligible, but eligibility is determined by some rather complex formulas that are applied to Canadian companies. For example, a Canadian-controlled private corporation (CCPC) can only pay eligible dividends up to the total amount in its “general rate income pool” (GRIP) at the end of the tax year.
For dividends to officially be recognized as eligible dividends, they have to be designated as eligible by the company paying the dividend. Private corporations can provide the designation in the form of a letter to dividend recipients or with a notation on dividend cheque stubs. Public corporations can designate dividends as eligible by simply putting a statement in writing that all dividends are eligible dividends unless specifically stated otherwise.
You can usually find a public corporation’s statement of dividend eligibility published on their website. The bottom line is that each company has the legal responsibility to notify shareholders if the dividends are classified as eligible or ineligible.
How the Tax Credit Works
Dividends are considered part of taxable income but not usually taxed at a person’s regular income tax rate, thanks to the dividend tax credit. To calculate the federal dividend tax credit, investors first have to “gross up” the total dividends they receive by a percentage specified by the Canada Revenue Agency (CRA). The required gross up percentage changes yearly, so be sure to check the current rate.
To explain, imagine someone earns ineligible dividends worth $150. As of 2017, they face a gross up rate of 38 percent. This means they have to report $207 as taxable income ($150 x 1.38). If their effective tax rate is 25 percent, their tax on this income equals $51.75.
As of 2016, the dividend tax credit for ineligible dividends is 10.5217 percent of the taxable amount of the dividend. In this case, that equates to $21.78 or ($207 x .105217). That reduces the original $51.75 in taxes owed to less than $30. Once your client claims the provincial dividend tax credit, they can save even more. The numbers are different for eligible dividends, but the process is the same.
Helping your clients save money is always a service that’s appreciated, and helping them get the full dividend tax credits they qualify for is one way to do that.