Tax Tips and Pits: Eligible or non-eligible, that is the question

The term "eligible dividends" applies to dividends paid by a Canadian corporation.

If you’ve received a T5 slip to include in your tax preparation, you may see the term “eligible dividends” or “other than eligible dividends” – referred to as non-eligible dividends – on these slips.

These terms apply to dividends paid by a Canadian corporation.

Because a corporation pays taxes on the earnings of the company before paying dividends, if the full amount of the dividends paid to a shareholder had to be included in that taxpayer’s income then, in effect, that income would be double taxed – once in the corporation’s books and then in the shareholder’s hands.

To avoid double taxation, Canada Revenue Agency (CRA) uses a formula to determine the value of dividends to be included as income, along with a mechanism to apply a credit for the corporate taxes already paid, effectively lowering the tax rate on this amount for the taxpayer.

For federal tax purposes, eligible dividends are grossed-up by 38 per cent and the dividend tax credit applied to this grossed-up value is 15.02 per cent.  And each province puts the dividend income through a similar gross-up and credit formula and these rates vary widely (read: wildly) with gross-ups from 5.4 per cent to 12 per cent resulting in effective tax rates of 19.29 per cent in Alberta to 35.22 per cent in Quebec.  BC is 28.68 per cent.

CRA has a second classification of dividends labelled “non-eligible dividends”.  These are paid by Canadian Controlled Private Corporations (CCPC).

A CCPC is a Canadian controlled and privately owned company – its shares must be held by Canadians and cannot be traded on any stock exchange anywhere in the world.

Its first $500,000 of gross revenue is taxed at a lower rate than the normal corporate tax rate to encourage small business investment and start-ups in Canada.

Despite being labelled “non-eligible”, the CCPC dividends are also subjected to the gross-up formula and dividend tax credit mechanism, albeit adjusted by CRA to reflect the lower corporate tax paid by a CCPC. The formula involves an 18 per cent gross-up and 11.02 per cent credit federally.  Provincially gross-ups range from 0.83 per cent to 7.05 per cent resulting in effective tax rates from 29.36 per cent in Alberta to 40.77 per cent in Manitoba with BC at 37.99 per cent.

Ignoring the math, CRA’s dividend taxation policy for shareholders of Canadian corporations – whether the corporation is big or small, public or private – is designed to reflect the underlying corporate tax paid before dividends are paid to its shareholders with credit given to the shareholder for those corporate taxes paid.   Without such a convoluted system, there would have to be a personal tax rate specific to dividend income.

Unfortunately the math can’t be ignored when it comes to tax preparation, but then again most computer programs are designed to deal with dividends of all sorts.   The trick of course, is to correctly identify the type of dividend and the appropriate box to input.

If you are preparing with pen and paper, may I humbly suggest the use of a calculator.

Ron Clarke has his MBA provides accounting and tax services. Email him at ron.clarke@JBSbiz.ca. To read previous Tax Tips & Pits columns visit www.JBSbiz.net.