Dividends are payments that you, as an investor, receive as a share of a corporation’s earnings. Some of the dividends you receive may be eligible dividends, while others may be called ordinary, or ineligible dividends.
An eligible dividend is simply one that has been given the status of eligible by the corporation that issued it. The type of dividends you receive has an impact on your tax return.
David M. Piccolo, B.B.A., J.D, tax lawyer at TaxChambers in Toronto says “corporations decide what will be paid out (whether the dividend will be) eligible versus ineligible.” “The shareholder (however), is the one impacted” he explains.
Piccolo explains how a corporation’s income gets added to a special account — this is called a General Rate Income Pool, or GRIP, account. “When a corporation chooses to pay dividends, it can elect to pay an amount up to the balance of the GRIP,” he said.
- The GRIP contains the corporation’s income that has not been impacted by any small-business deduction or any other special tax rates.
- The purpose of a GRIP is to allocate such income and have this income taxed appropriately.
- If a corporation’s dividends exceed the amount of its GRIP, it must pay a tax on the dividends called Part III.1 tax at a federal rate of 20 percent, says the Canada Revenue Agency.
A corporation has a duty to notify you that it is going to issue eligible dividends.
The corporation may send you a letter or a cheque stub indicating an eligible dividend. Some public corporations state that all of the dividends issued are eligible unless otherwise indicated. This is an acceptable form of notification. Other forms of notification include notification on the corporation’s website, in quarterly or annual reports and in shareholder newsletters or other publications, the CRA says.
Piccolo also says that corporations are required to issue T5 slips to the shareholders, which will be included with the shareholder’s tax return. The information from this slip will help you file your taxes.
Gross-Ups And Dividend Income
Both eligible and ineligible dividends have a gross-up rate that you must include on your return. A gross-up is an additional amount included to account for any taxes. For eligible dividends, the gross-up rate is 38 percent, as of 2013.
For instance, if you received a $100 eligible dividend, the grossed-up value of the dividend is:
($100 x 38 percent) + $100 = $138
Therefore, $138 is the amount you would include, as income, on your tax return. For ineligible dividends, the gross-up rate is 18 percent, for dividends paid after 2013 (the rate is 25 percent for the year 2013 and prior), the CRA reports.
Impact On A Tax Return
Your tax bracket and tax liability are functions of your taxable income. Dividends increase your taxable income. This increase to your taxable income therefore increases the amount of tax you are required to pay.
- The dividend tax credit is a non-refundable credit that offsets the gross-up amount. You are allowed to claim a little more than half of the gross-up amount as a non-refundable tax credit.
- Non-refundable credits reduce your tax liability, and a portion –15 percent in fact — of these credits are directly deducted from your federal tax amount, according to the CRA.
- If you have enough non-refundable credits, your tax liability can be reduced to $0, but these credits cannot, however, take your tax liability into the negative.