If you earn dividends from a Canadian corporation, you may have heard of the Dividend Tax Credit (DTC)—but what exactly is it, and how does it help lower your taxes?
The DTC is designed to prevent "double taxation" on dividends. Since corporations already pay taxes on their profits before distributing them to shareholders, the government offers this credit to ensure you don’t pay full taxes on the same income again.
In this guide, we’ll cover:
- What the Dividend Tax Credit is and why it exists
- The difference between eligible and non-eligible dividends (and why it matters)
- How to claim the credit on your tax return
By the end, you'll have a clear understanding of how the Dividend Tax Credit works and how it can help you keep more of your investment income.
And if you'd rather have Joe explain it to you, check out our video on the topic!
What Is the Dividend Tax Credit?
Alright, first things first, what exactly is the Dividend Tax Credit, and why does it matter?
Dividends are essentially a portion of a corporation’s profits that are distributed to its shareholders.
For example, if you own shares in a company, the dividends you receive are your share of that company’s after-tax profits.
But here’s the thing, because the corporation already paid taxes on those profits, taxing you again on the full amount wouldn’t exactly be fair. That’s where the Dividend Tax Credit comes in.
The Dividend Tax Credit is Canada’s way of reducing what’s known as "double taxation." It gives individuals a tax break when they report dividends on their personal tax returns.
Essentially, it makes dividend income more tax-efficient than other forms of income when reported on your personal tax return.
Dividend Tax Credit Example
Here’s a quick example. Let’s say a corporation earns $100 in profit. It pays taxes on that amount and then distributes the remaining profit to you as a dividend.
Without the Dividend Tax Credit, you’d pay taxes on the entire amount again, even though part of it has already been taxed at the corporate level. The dividend tax credit steps in to prevent that.
It’s important to note that this tax credit is specifically for individuals receiving dividends from Canadian corporations. If you’re receiving dividends from a foreign company or if your corporation is earning dividends, the credit doesn’t apply.
Eligible vs. Non-Eligible Dividends
Not all dividends are created equal. There are two main types of dividends in Canada: eligible and non-eligible dividends.
Eligible Dividends
Eligible dividends are typically paid by large public corporations or Canadian-controlled private corporations (CCPCs) that are taxed at the higher general corporate tax rate.
Because these corporations already pay a significant amount of tax on their profits, the government offers an enhanced Dividend Tax Credit to shareholders receiving these dividends.
Eligible dividends are "grossed up" by 38% for tax purposes. That means the amount you report on your tax return is artificially increased to reflect the pre-tax amount. But don’t worry, the enhanced tax credit offsets this.
Non-Eligible Dividends
Non-eligible dividends, also known as “other than eligible dividends,” are paid by CCPCs that benefit from the Small Business Deduction. These companies are taxed at a lower rate, which means the dividends they distribute receive a smaller Dividend Tax Credit.
Non-eligible dividends are grossed up by only 15%, which results in a lower taxable amount than eligible dividends. The corresponding tax credit is also smaller to match the lower corporate tax rate paid by the company.
Key Differences
We can quickly summarize the key differences.
- Eligible dividends have a higher gross-up and also a higher tax credit.
- Non-eligible dividends have a lower gross-up and also a lower tax credit.
What About Foreign Dividends?
It’s worth noting that foreign dividends, like those from U.S. or international stocks, don’t qualify for the Dividend Tax Credit. Instead, they’re taxed as regular income, which can result in a higher overall tax bill.
Why It Matters
Understanding the difference between eligible and non-eligible dividends is key for tax planning. For example, as a business owner, knowing what type of dividends your corporation is paying can impact your overall tax strategy.
How Dividend Tax Credits Work
Now that we know what the Dividend Tax Credit is and the difference between eligible and non-eligible dividends, let’s look at how it actually works.
The Gross-Up Process
When you receive dividends, the first step is the gross-up. This artificially increases the amount of dividend income reported on your tax return to reflect the pre-tax income the corporation earned.
Here’s how the gross-up works:
- Eligible Dividends: Grossed up by 38%. So, if you receive $100 in eligible dividends, you’ll report $138 on your tax return.
- Non-Eligible Dividends: Grossed up by 15%. If you receive $100 in non-eligible dividends, you’ll report $115 on your tax return.
This gross-up ensures that dividends are taxed as if you were receiving the corporation’s pre-tax income.
Applying the Dividend Tax Credit
Once the grossed-up amount is included in your taxable income, the Dividend Tax Credit comes into play. It reduces the taxes owed on that grossed-up amount.
There are two parts to the Dividend Tax Credit:
- Federal Dividend Tax Credit: Applied to your federal taxes and calculated as a percentage of the grossed-up dividend.
- Provincial Dividend Tax Credit: Each province and territory offers its own credit, and the rates vary depending on where you live.
The combination of these credits ensures that you’re not overtaxed, making dividend income more tax-efficient than other forms of income like interest or salary.
Why the Gross-Up and Credit System?
This system may seem a little complicated, but it’s designed to achieve integration. The idea is to make sure the total taxes paid by both the corporation and the shareholder are roughly equivalent to what the shareholder would pay if they had earned the income directly.
Key Takeaway
The important thing to remember is that the Dividend Tax Credit doesn’t eliminate taxes on dividends, but it does significantly reduce them.
By offsetting the taxes you owe on the grossed-up dividend income, the credit ensures you’re not taxed twice on the same corporate profits.
Who Benefits from the Dividend Tax Credit?
The Dividend Tax Credit is designed to help individuals who receive dividend income from Canadian sources.
Business Owners
If you’re a shareholder in your own Canadian corporation, the Dividend Tax Credit can play a big role in how you choose to pay yourself. Many business owners take dividends instead of, or in addition to, a salary.
There are quite a few moving pieces that come into play when deciding how to pay yourself as a business owner. For that reason, we’ve got an entire separate video on salary vs dividends linked in the description below.
Investors in Canadian Companies
And if you hold shares in Canadian corporations, particularly public companies, the Dividend Tax Credit makes dividends a great source of tax-efficient income.
Eligible dividends from Canadian stocks not only provide you with steady income, but the credit also helps reduce the taxes you pay on that income.
The dividend tax credit is a valuable tool for reducing your tax burden if you’re a Canadian business owner or investor.
How to Claim the Dividend Tax Credit
For most people, claiming the Dividend Tax Credit is simple, just enter the information from your tax slips into tax software or hand them over to your accountant.
Here’s how it works:
Step 1: Gather Your Tax Slips
When you earn dividend income, you’ll receive tax slips that detail everything you need to report. These include:
- T5 Statement of Investment Income: For most dividends.
- T3 Statement of Trust Income Allocations: For mutual funds or certain trusts.
- T4PS or T5013: For profit-sharing plans or partnerships - these are less common, though.
Step 2: Enter the Information Into Tax Software
- Simply plug the numbers from your tax slips into your tax software, and it will handle the gross-up and apply both the federal and provincial Dividend Tax Credits automatically.
Step 3: Review and File
- Double-check the summary in your tax software to ensure the credits have been applied correctly.
- If you’re working with an accountant, they’ll take care of the calculations and reporting for you.
And that’s it. For most Canadians, claiming the Dividend Tax Credit is as easy as entering the numbers from your tax slips into tax software. Just make sure you have all your slips organized, and you’re good to go!
Summary
The Dividend Tax Credit is a valuable tool for reducing the taxes you owe on dividend income from Canadian corporations.
Whether you’re a business owner deciding how to pay yourself or an investor looking for tax-efficient income, understanding how it works can help you save money.
And if you’re a business owner looking for personalized advice on dividends or tax planning, we’re here to help! Reach out to Avalon Accounting, and we’ll guide you through it all.
Alright, that does it for this video, thanks for watching and we’ll see you in the next one!
