Understanding Dividend Taxation in Canada
In Canada, all sources of income must be disclosed in your tax returns, whether from your salary, business/side hustle, investments, or property sale. Each of these incomes is taxed differently. When it comes to stock market investments, you earn income through dividends and capital appreciation from selling shares/ETFs at a higher price. A company gives dividends to its shareholders from its after-tax profit. However, the dividend is taxable in the hands of shareholders. Fortunately, the Canada Revenue Agency (CRA) provides a non-refundable Federal Dividend Tax Credit to individuals on their dividend income.
How is Dividend Taxed in Canada?
The tax on dividends is paid partially by companies and partially by individuals who receive it. To ensure both parties are not double taxed, the CRA allows individuals to deduct the Federal Dividend Tax Credit from their total taxable dividend income.
Since you receive the dividend after the company has paid its tax, the CRA requires you to gross up the dividend income to arrive at the total taxable value. Once you have the total taxable dividend, you deduct the federal tax credit from your tax bill. The credit represents the tax the corporation has already paid on your dividends.
Since it is a non-refundable tax credit, you can avail yourself of the credit amount until your tax bill is reduced to $0. Any remaining tax credit goes unused since it is non-refundable. Similarly, there is a provincial dividend tax credit that works in the same way as the federal dividend tax credit. There are three different types of dividends, each taxed differently.
Types of Dividends
Canadian corporations classify dividends based on the amount of corporate tax they pay.
- Eligible Dividends: These are dividends where the corporation has paid a higher tax rate. If your dividend is eligible, you must add back 38% of your received dividend and deduct 15.0198% from the gross taxable amount as a federal dividend tax credit.
- Other than Eligible Dividends: These are dividends where the corporation has paid a lower tax rate. If your dividend is classified as other than eligible, you must add 15% to the dividend you received and then deduct 9.0301% from the gross taxable amount as a federal dividend tax credit.
- Foreign Dividends: These are dividends paid by foreign corporations to Canadian shareholders. Such dividends do not qualify for the Canada dividend tax credits, and you must pay full tax on the dividend amount from foreign companies.
Computation of Federal Dividend Tax Credit
Let’s understand the taxation of dividend income with an example.
Example
Katherine earned $100 in eligible dividends and $200 in other-than-eligible dividends from her investments in two Canadian corporations. She falls under the 20.5% tax bracket.
Step 1: Calculate the Gross Taxable Amount
- Eligible gross dividend: $138 ($100 x 1.38)
- Other than eligible gross dividend: $230 ($200 x 1.15)
The total taxable dividend income is $368. Katherine will report this total taxable dividend on line 12000 and line 12010 of her income tax return. Since her effective tax rate is 20.5%, she would have had to pay $75.44 federal tax on this income.
Step 2: Deduct the Federal Dividend Tax Credit
She can deduct the tax paid by the corporations using the federal dividend tax credit.
- Eligible dividend credit: $20.73 ($138 x 0.150198)
- Other than eligible dividend credit: $20.77 ($230 x 0.090301)
The total federal dividend tax credit is $41.49. This credit amount will appear on her T5, T4PS, T3, or T5013 slips. She will pay $33.95 ($75.44 – $41.49) federal tax on the $300 dividend she received.
Katherine must claim the tax credit on Line 425 on Schedule 1 of her federal income tax return to ensure she gets the tax credit. For the provincial credit, she will have to fill out Form 428. Once she files her income taxes, the tax amount will be adjusted for credits.
If Katherine received the above dividends from her investments through the Tax-Free Savings Account (TFSA), the dividends would be exempt, and she wouldn’t have to report them in her tax filings.
The federal dividend tax credit is just one of the many tax credits available to Canadians. These calculations can get overwhelming towards the end of the year, and you might miss out on some of the tax credits available to you.
Contact Ghumans to Help You with Taxes
Navigating the intricacies of tax credits and deductions can be challenging. If you need assistance, contact Ghumans for expert guidance on maximizing your tax savings and ensuring compliance with CRA regulations.