What Is the Dividend Tax Credit?
The dividend tax credit is the amount that a Canadian resident applies against his or her tax liability on the grossed-up portion of dividends received from Canadian corporations. The gross-up and the dividend tax credit are applicable to individuals, not corporations.
What Is A Dividend?
- Canadian residents apply for dividend tax credits against tax liabilities on the grossed-up portion of dividends received from Canadian corporations.
- Gross-up and dividend tax credits only apply to individuals.
- There are often federal and provincial tax credits.
Understanding the Dividend Tax Credit
The eligible dividends an individual receives from Canadian corporations are "grossed up" by 38%, as of 2018. For dividends to officially be recognized as eligible dividends, they have to be designated as eligible by the company paying the dividend. The gross-up rate for non-eligible dividends, as of 2019, is 15%. Think of a gross-up as an increase to account for applicable taxes.
For example, if a company pays $20 dividends per share, investors will receive $20 x 1.38 = $27.60 per share, meaning that their dividends after taxes will be $20 per share. The grossed-up amount is included in the taxpayer’s income tax form as taxable income. Both Canadian federal and provincial governments then grant individuals a tax credit equal to a percentage of the grossed-up amount, which helps to reduce the actual tax payable.
The amount the eligible dividends an individual receives from Canadian corporations are "grossed up" by as of 2018.
For example, let’s assume Susan Smith has an effective tax rate of 25%. She receives $250 in eligible dividends and $200 in non-eligible dividends during the 2018 tax year. To calculate the federal dividend tax credit, she has to gross-up the total dividends she receives by the percentage specified by the Canada Revenue Agency (CRA). In this case, the percentages are 38% for eligible dividends and 15% for non-eligible dividends.
- = ($250 x 1.38) + ($200 x 1.15)
- = $345 + $230
- = $575
This means that Susan reports $575 as taxable income. Since her effective tax rate is 25%, her tax on this income will be:
- = $575 x 0.25
- = $143.75
The federal dividend tax credit as a percentage of taxable dividends is 15.0198% for eligible dividends and 9.0301% for non-eligible dividends. Her dividend tax credit on the federal level will be:
- = ($345 x 0.150198) + ($230 x 0.090301)
- = $51.82 + $20.77
- = $72.59
The tax credit, thus, reduces Susan’s original tax liability to $143.75 – $72.59 = $71.16.
Note that there are both federal and provincial tax credits. For example, if Susan lives in the province of Alberta, she can claim a provincial tax credit of 10%, which when applied to her dividends, can further decrease her tax liability.
Dividend tax credits are non-refundable credits that are implemented in an attempt to offset double taxing since dividends are paid to shareholders with a corporation's after-tax profit and the dividends received by shareholders are also taxed. Dividends received from a foreign corporation are not subject to the gross-up and dividend tax credit mechanisms. Therefore, you'll pay a higher rate of tax on dividends from a foreign corporation.