Dividend Credit All About Creating Even Tax Field | FBC, Canada's Farm & Small Business Tax Specialist

Dividend Credit All About Creating Even Tax Field

It might have been prompted by the spirit of the season. Then again, election campaigns have been known to loosen the purse strings of many a government seeking a return to power. Regardless, goodies are goodies.

One recently announced by the federal government is an increase in the tax credit applied to dividends from large corporations.

Dividends from Canadian companies qualify for a tax credit that works like this: The dividend is grossed-up by 25 per cent so you actually report 125 per cent of the dividend as income. You then get to claim 13.3 per cent of the grossed-up dividend as a tax credit, which reduces your federal tax payable.

Then, when you add the dividend tax credit offered by each of the provinces, which is usually half the federal amount, the total credit is closer to 20 per cent of the grossed-up amount of the dividend.

The proposed new dividend tax credit bumps the gross-up to 145 per cent of the dividend and the federal tax credit to 19 per cent.

If the provinces increase their dividend tax credit to match the federal move as expected, the combined federal-provincial tax rate will be close to 30 per cent of the grossed-up amount. This all translates into an effective top marginal tax rate on dividends of about 21 per cent compared with the top marginal tax rate on other ordinary income and interest that ranges from a low of 39 per cent in Alberta to a high of 46.4 per cent in Manitoba.

The new credit will apply only to dividends paid after 2005 by Canadian public corporations and non-Canadian corporations that are residents in Canada and are subject to the general corporate tax rate. The dividends of Canadian controlled private corporations that benefit from the small business tax rate will continue to reflect the previous gross-up and dividend tax credit rates.

Part of the motivation for this move is to create a level playing field between the ways in which dividends and distributions from income trusts are taxed.

In Canada, corporate income is subject to corporate income tax. Dividends are paid out of after-tax corporate dollars to individuals who then must pay personal taxes on the dividends. This, in effect, amounts to double taxation of dividends. Distributions from income trusts, on the other hand, are not taxed at the corporate level but only in the hands of the investor at their appropriate personal marginal tax rate. In other words, such distributions are only taxed once.

In the United States, dividends are taxed only once between the corporation and individual. By increasing the size of the dividend tax credit, total taxes paid by the corporation and the shareholder will be roughly identical for dividends and income trust distributions.

"As long as you’re going to be thinking anyway, think big." — Donald Trump