Dividend Tax Credit

The dividend tax credit is the amount that a Canadian resident applies against his/her tax liability on the grossed up portion of dividends received from Canadian corporations. The gross-up and dividend tax credit are applicable to individuals, not corporations.

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 2018, is 16%. 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 on 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.

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 16% for non-eligible dividends.

= ($250 x 1.38) + ($200 x 1.16)

= $345 + $232

= $577

This means that Susan reports $577 as taxable income. Since her effective tax rate is 25%, her tax on this income will be:

= $577 x 0.25

= $144.25

The federal dividend tax credit as a percentage of taxable dividends is 15.0198% for eligible dividends and 10.0313% for non-eligible dividends. Her dividend tax credit on the federal level will be:

= ($345 x 0.150198) + ($232 x 0.100313)

= $51.82 + $23.27

= $75.09

The tax credit, thus, reduces Susan’s original tax liability to $144.25 - $75.09 = $69.16.

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.