If you are a shareholder in a Canadian corporation, you may earn dividend income, which should be reported on your tax return. Typically, you also may be eligible to receive the federal dividend tax credit.
This is a non-refundable credit that reduces the amount of tax you owe. Balvir Singh Saini, a certified general accountant from Brampton explains that “the dividend tax credit is given to avoid double taxation.”
Eligible and Ineligible Dividends
Corporations designate dividends as eligible or ineligible. The difference is negligible to you, except for tax purposes. As an investor, you’ll be able to note on your T5 statement of investment income whether your dividend is eligible or ineligible.
If you’re an employee who works for the corporation, you’ll receive a T4PS, which is a statement of employee profit sharing plan allocations and payments.
According to the Canada Revenue Agency, other statements that may include dividend income are:
- A T3, statement of trust income allocations and designations;
- A T5013, statement of partnership income;
- A T5013A, statement of partnership income for tax shelters and renounced resource expenses.
Dividend Income and Gross Up
Your dividend income gets added to your taxable income. In addition to reporting the amount you earned in dividend income, you should account for a gross up. Think of a gross up as an increase to account for applicable taxes.
For example, say your job pays $5,000 per week, but your salary is $5,500 per week because your employer wants $5,000 to be your income after taxes. This means your employer has grossed-up your salary.
The CRA has you add in a gross up to account for any tax the corporation has already paid on your dividend income.
Currently, the gross up rate is 38 percent for eligible dividends. Beginning in the tax year 2016, the gross up rate on ineligible dividends is 17 percent. This rate is slated to drop an additional one percent per year for the next two years.
The decrease is due to “corporate taxes going down,” Saini says.
Calculating Dividend Income With Gross Up
As an example, if you received $200 worth of eligible dividends and $200 worth of ineligible dividends, you would have to gross up you eligible and ineligible dividends by 38 percent and 25 percent, respectively. So, you would claim $526 as dividend income on your return:
- ($200 X 138 percent) = $276 ($200 X 125 percent) = $250 $276 + $250 = $526
Calulating the Credit
The CRA allows you to calculate the federal dividend tax credit one of two ways:
- As a percentage of the grossed up value of your dividend income (15.0198% of eligible dividends, as of 2015);
- As a fraction of the gross up portion of your dividend income (6/11 of eligible dividends; as of 2015).
Continuing the example, a $200 eligible dividend had a grossed up value of $276, so either method of calculation would produce the same results:
- $276 X 15.0198 percent = $41.45 2) $76 X (6/11) = $41.45
Why You Receive Credit
The purpose of the federal dividend tax credit is to balance things out. You receive your share of the corporation’s earnings as a dividend.
You pay a gross up to turn that income back into pretax income — because the corporation has already paid taxes on it — then, you receive a tax credit to make it fair for everyone.
Both you and the corporation aren’t being double-taxed and the CRA subsidizes you for the tax the corporation already paid on your dividends.
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