Personal & Corporate Tax
Taxes on Different Types of Dividends
The Concept of Integration – Active Business Income
A dividend typically represents business or investment profits earned and distributed by a corporation to its shareholders.
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. This is known as the concept of integration – the basic principle is that an individual should pay approximately the same amount of tax whether the income is earned personally, or earned through a corporation and the after-tax profits are distributed as a dividend. Without providing credit for corporate taxes paid, this additional layer of tax would discourage ownership of shares in public and private corporations.
A dividend paid by a Canadian corporation can be classified as an “eligible”, “non-eligible” or a “capital” dividend. The tax implications and rates applied to each type of dividend is meant to reflect both the underlying taxation of income within the corporation as well as the tax that would be payable if such income were earned directly. Generally, a Canadian controlled private corporation (CCPC) is eligible for a lower tax rate on its first $500,000 of income (13.5% in Ontario for 2018) and is taxed at a higher rate thereafter (currently 26.5% in Ontario). Corporate income that has been taxed at the higher rate can be paid as an eligible dividend, whereas, income that has been taxed at the lower rate small business deduction rate will be paid as an ineligible dividend.
Eligible dividends are generally received from public companies or private corporations with relevant eligible dividend tax pool balances, known as general rate income pool or GRIP. 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.
Non-eligible dividends are generally received from Canadian private corporations that have paid the lower tax rate on the first $500,000 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.
The actual dividend tax rates by province can be accessed on: http://www.taxtips.ca/marginaltaxrates.htm
For Ontario the top marginal tax rate on non-eligible dividends is 46.84% and for eligible dividends it is 39.34%.
When a corporation realizes a capital gain, one-half of the gain is taxable and the other one-half is not taxable and is added to what is known as the capital dividend account (CDA). As well, a capital dividend credit is available when a corporation receives an insurance death benefit, equal to the difference between the death benefit and the adjusted cost basis of the insurance policy. Tracking the CDA is important since Capital Dividends can be paid out of a corporation and received by an individual tax-free. They can play an important part in estate planning since the payment of capital dividends can help reduce the tax liability arising from the deemed disposition of shares on death.
For information on capital dividends, please see Capital Dividend Account.