Dividend Gross-Up And Dividend Tax Credits – A Toronto Tax Lawyer Analysis | David J. Rotfleisch

Over the years, our financial literacy has changed considerably. Economic crises have taught us that having savings is not enough to survive. Different types of insurance have emerged to provide an extra layer of protection. Now, having passive income through different types of investments is a popular trend. 

The stock market is a common manifestation of growth in the financial sector. Earnings are given through stocks or dividends. Yet, tax is a life’s constant that exists almost everywhere. Nevertheless, it can be a great help to investors in more ways than you think. 

Hence, we will take a look at dividend gross-up and tax credits. We will show you how to compute them to understand them better. 

The Basics of Dividends and Dividend Tax

We must understand that dividends can take two forms. Companies can distribute dividends as cash or stocks. Stock dividends happen when the company does not have enough cash or during stock splits. In essence, these are given in percentage per existing share and not subject to taxes. But, things will change once the owner sells his shares. 

Meanwhile, cash dividends are subject to taxes under the Canadian Income Tax Act. These are more common than stock dividends. The company may or may not increase it, depending on its financial capacity. Those who had consistent increases for 25 years are called Dividend Champions. In general, these companies provide more security for long-term investors. But, they may also reduce or cut dividends like what happened in most companies in 2020. 

In general, dividends are distributed quarterly or semi-annually. They depend on the reporting frequency of the company. Often, an investor receives dividends a few weeks after the release of the report. The dividend tax rate ranges from 30% to 50% of the final value of dividends. Also, dividend taxes vary with eligible and non-eligible dividends. This will be discussed in the latter part of this article. 

Federal Dividend Tax Credit in Canada 

In line with the Federal Dividend Tax Credit in Canada, you must file your taxable dividends. You have to report these on line 12000 of your ITR (Income Tax Return). Whether eligible or non-eligible dividends, you have to report them in the same manner. They apply to dividends earned from Canadian companies. 

There’s a federal worksheet to help you compute the taxable dividend income. The worksheet will point you to the appropriate statement or file for your reporting. With that, you can declare your taxable dividend income in the tax return. For further queries, you may click this link for your reference. 

Dividend Gross-Up And Dividend Tax Credits 

Before the final taxable amount, dividend gross-up and tax credits are applied first. These are the amounts that Canadians use against tax liabilities on dividends. From the word itself, dividend tax credits act as a reduction in dividend taxes. Remember that both profits and dividends are subject to taxes. As such, both the corporation and investors are taxpayers. 

But, keep in mind that they only apply to individuals, not corporations. Their primary purpose is to prevent double taxation. The percentage of gross-up and tax credits vary according to the type of dividends. Dividends are either eligible and non-eligible in Canada. Here is how to classify these dividend types. 

Eligible Dividends 

Canadian resident corporations distribute eligible dividends to Canadian residents. These are designated in writing to inform investors of the eligibility of dividends. Companies are free to distribute these as long as they don’t have a low-income rate pool (LRIP). This guideline is in line with Section 89(14) of the Canadian Income Tax Act. 

Generally, eligible dividend gross-up and tax credits on eligible dividends are higher. Most companies distributing these do not qualify for small business reductions. They pay higher corporate taxes, so dividend taxes are set at preferential rates. Hence, it appears to be more beneficial regardless of the province and tax bracket. 

Non-Eligible Dividends

Meanwhile, non-eligible dividends come from companies that qualify for small business reductions. Often, these are Canadian Private Controlled Corporations (CCPC). Corporate income taxes are only set at 15%. As such, tax treatments are less favourable, and dividend tax credits are lower. Even so, CPCCs can distribute eligible dividends if they do not exceed the GRIP. 

Computation of Dividend Tax Credits 

The dividend tax credit and gross-up are the actual benefits of dividend taxation. As mentioned, they prevent double taxation since both profits and dividends are taxable. The order of computation is as follows:

• Dividend gross-up

• Dividend tax on grossed-up dividends

• Dividend tax credits

• Dividend tax 

Eligible Dividends 

The dividend gross-up for eligible dividends is 38%. Meanwhile, the Canadian dividend tax credit is 15.0198%, respectively. These are more favourable for investors due to lower dividend tax. For instance, Mr. ABC receives eligible dividends of $500 with an effective tax rate of 25%. After accounting for dividend gross-up and tax credits, he will pay $68.86. Here is how to compute his dividend tax. 

Dividend Gross-Up

$500 + ($500 * 0.38) = $690

Grossed-Up Dividend Tax

$690 * 0.25 = $172.50 

Dividend Tax Credits

$690 * 0.150198 = $103.64

Dividend Tax

$172.50 – $103.64 = $68.86 

Non-Eligible Dividends

The gross-up and tax credits for non-eligible dividends are 15% and 9.0301%, respectively. Investors pay higher taxes, making non-eligible dividends less favourable for them. Hence, Mr. ABC will pay higher dividend taxes. After taking dividend gross-up and tax credits into account, he will arrive at $91.83. Here is how to compute the non-eligible dividend tax. 

Dividend Gross-Up

$500 + ($500 * 0.15) = $575

Grossed-Up Dividend Tax

$575 * 0.25 = $143.75 

Dividend Tax Credits

$575 * 0.090301 = $51.92

Dividend Tax

$143.75 – $51.92 = $91.83  

Hence, the eligible dividend tax is $22.97 lower than the non-eligible dividend tax. For sure, Mr. ABC knows which type of dividends to choose. But if he has both, the total amount is $160.69. Hence, he does not have to pay as much as the corporation does. 

Let an expert handle your tax woes and avoid penalties.  Book an appointment with the experts from Rotfleisch & Samulovitch P.C.

Contact a Toronto Tax Lawyer Today

Whether a company is public or private, investors receive dividends. Taxes depend on the dividends that the company distributes. But the thing is, the amount of dividend payments varies from company to company. As such, it is wise to assess the financial capacity of the company to sustain dividends. 

More so, it is a must to determine how dividends are distributed and how much tax you must pay. Yet, the computation may be pretty long and complex. You may speak with a tax professional to understand it better. Hence, you may reach out and seek assistance from Taxpage for further information.