Dividend Distributions

As a shareholder of a public company, you’re eligible to participate in the sharing of profits in the form of dividend distributions. A company will pay out dividend distributions when there is growth in the business and a strong likelihood of long stream of cash flows. Any profits are either reinvested back into the company or paid out to shareholders in a form of a dividend.

Types of Dividend Distributions

There are three types of dividends, eligible, ineligible and capital dividends, each discussed below. The type of dividends you receive impacts your tax return.

Eligible Dividend Distributions

• Eligible Dividends – Eligible dividends are paid out by public corporations that reside in Canada or Canadian Controlled Private Corporations. When a dividend is paid out by a corporation, they have to designate each eligible dividend that they pay, as required by the Income Tax Act. These type of dividends are taxed at lower tax rate due to “dividend gross up” and eligibility for the Enhanced Dividend Tax Credit. The gross up amount for eligible dividends is 38%. Canadians prefer to receive eligible dividends from Canadian corporations as they’re treated more favorably during tax time.
  • Gross Up: Dividends are “grossed up” because they’re paid from a corporation’s after tax profits. Tax has already been paid. To prevent double taxation, dividend distributions are grossed up and offset by a dividend tax credit. Adding the gross up amount to the dividend is as if the corporation had not pay corporate income tax. The grossed up amount of dividend is added to your income but keep in mind that the Enhanced Dividend Tax Credit gives you credit for the amount of tax that the corporation has already paid. This would prevent double taxation.
  • Gross Up Amount of Eligible Dividends: 38% (2020)

Ineligible Dividend Distributions

• Ineligible Dividends – Non eligible dividend distributions are regular dividends paid out by Canadian corporations, public or private. These dividends are taxed at a lower corporate income rate and not eligible for the enhanced dividend tax credit.
  • Gross Up: Non-eligible dividends are grossed up as well but at a lower rate to reflect for the lower tax paid. The grossed up amount must be included in your income which will be offset by a dividend tax credit. The dividend tax credit percentage for ineligible dividends is lower than eligible dividends to reflect for the lower tax rate the corporation paid.
  • Gross Up Amount of Ineligible Dividends: 15% (2020)

Dividend Tax Credit

When dividend distributions are paid by a corporation, they’re either coded as eligible or ineligible. Depending on the type, these dividend distributions are grossed up and included in a taxpayer’s income. However, they’re offset by a Dividend Tax Credit. This dividend tax credit prevents double-taxation of dividend income since the corporation already paid tax on the dividends. Below is an example of the taxation of a eligible dividend.

• Example of Gross Up of Eligible Dividends: James received $1,000 of eligible distributions from a Canadian corporation in 2019. He received this dividend amount out in his non registered account. Keep in mind that you can’t gross up dividends in a registered account. On his T5 tax slip, James would see three amounts regarding this dividend.
  • • Eligible Dividend Amount: $1,000
      • This amount of $1,000, is paid to you with company’s after tax profits.
    • Grossed Up of Eligible Dividend Amount: $1380
      • The $1,000 dividend is grossed up by 38%. This is approximately how much pretax profit the corporation would have had to earn in order to pay you the $1,000 in distributions. This assumes a tax rate of 38%. The amount of $1380 is added to your income.
    • Federal Dividend Tax Credit: $1380 x 15.02% = $207.28
      • The dividend tax credit helps offset the gross up amount for the eligible dividend and gives you credit for approximate amount of tax that the corporation has already paid. The Federal Dividend Tax Credit on eligible dividend rate is 15.02%.
    • Provincial Dividend Tax Credit: $1380 X 10% (ON) = $138.0
      • On top of the federal tax credits, provinces also have their own additional tax credit that they provide. In Ontario, this amount is 10%. However, this varies from province to province.

Capital Dividends

Capital dividends are considered “return of capital” and paid out of a corporation’s capital dividend account (CDA). The capital dividend account is a special corporate tax account under the Income Tax Act, designated to allow tax-free amounts received by a private corporation to be distributed tax free to shareholders of the corporation. All private corporations in Canada including, non Canadian controlled are eligible to have a capital dividend account. The capital dividend account is to be monitored and reported on a corporation’s T2 corporate income tax return.

Corporate life insurance policies typically get deposited in a corporation’s capital dividend account.

• Example: If the corporation were to receive a death benefit of $1,000,000 and the adjusted cost base of the policy at the time of the insured holder’s death is $100,000, there will be $900,000 credited to the corporation’s Capital Dividend Account. The $900,000 would be paid tax-free to the share holders while the $100,000 would be paid to shareholders as a taxable dividend.