Winston Churchill is reputed to have said, “We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.”
While that calls to mind a humourous impossibility, the truth is that many people find the tax code equally as ludicrous. Its sometimes conflicting and hard-to-understand provisions are beyond the scope of many individuals.
The income tax in Canada includes multiple provisions that apply to federal, provincial and local taxes, governing codes and regulations, and periodic credits and exemptions that apply in certain situations.
Navigating the landscape of tax accounting is not an easy tax. At tax time, the assistance of a professional tax accountant or attorney can be invaluable.
Payment of personal and corporate tax, in Canada as in most nations, is a reality, and is generally deemed necessary for the continued existence of government services. Tax evasion is punishable by law in most countries, and knowing at least basic information about how taxes are levied is valuable for any citizen. Although taxes provide the funding for the services and benefits enjoyed by Canadian citizens, most citizens endeavour to pay as little in annual tax as allowable under the law.
In Canada, the rules that surround corporate dividend tax is complicated by provisions that allow some taxpayers to use a portion of such tax as the basis for a corresponding tax credit.
Here are some basic facts that taxpayers need to know:
What are Corporate Dividends?
Corporations are allowed to make payments to investors and shareholders in only a few specific ways. The payment of dividends is in some ways a reward to investors for the corporation’s use of funds invested by those shareholders. Dividends typically represent a share of profit that is returned to the shareholder on an annual basis.
Canadian corporations are subject to income tax on earnings, and most typically pay corporate tax on dividends that are subsequently distributed to shareholders.
Dividends also become taxable to those individual shareholders as a type of income.
Although dividends are typically cash payments, they may also be issued in the form of additional shares, or through a reinvestment offer. Dividends are issued equally, on a per share basis, to all existing shareholders as of the date the dividend is declared. Certain other regulations apply to how dividends are treated, both by the corporation and by individuals.
How are Corporate Dividends Taxed?
Although all corporate dividends, including dividends issued by foreign corporations, are subject to tax, Canadian citizens who hold stock in Canadian corporations get a tax break designed to prevent double taxation. It is a concept that might be difficult to understand, but essentially it involves a formula applied to Canadian corporate dividend payments to provide a tax credit equal to the amount of tax already levied on the corporation.
Foreign dividends are taxed as ordinary income. There is no possibility of double taxation because foreign corporations are not subject to Canadian tax.
Dividends are taxed at a rate different from interest, and under guidelines issued by the Canadian Revenue Agency, eligible dividends qualify for a tax credit in an effort to keep taxes as fair and equitable as possible.
The Canadian Revenue Agency administers tax law, and represents the final authority in tax matters for the government. The agency is charged with applying tax across the board.
TYPES OF DIVIDEND (Eligible & Ineligible) UNDER CANADIAN INCOME TAX ACT
Canadian corporations may designate dividends as either “eligible” or “ineligible.” The designation has little meaning for individual shareholders or investors, except at tax time, when it has a definite effect on individual tax liability.
The difference refers to the eligibility of the recipient to qualify for tax credit on those dividend payments. Canadian investors receive a T5 statement of investment income that notes whether a dividend is eligible or ineligible. The designation affects how the income will be reported on the tax return, and whether it qualifies for a “gross up” calculation which activates a corresponding qualification for a tax credit even though it increases the actual amount reported as income.
Eligible dividends qualify for a gross up rate of 15% in 2019. (Previously, the gross up rate was 38%.) What it means to individual taxpayers is that the actual dollar amount of the dividend must be reported on tax returns as the higher (gross) amount, representing the pre-tax sum of the authorized payment. In return, individual taxpayers receive a tax credit for the amount of tax already paid by the corporation. If it sounds somewhat complicated, it can be.
Although it can seem burdensome to figure “gross up” amounts and percentages, as well as applicable credits, at tax time, it is an effort to avoid double taxation on behalf of both individuals and corporate entities.
The best advice is to seek clarification from a knowledgeable tax adviser, accountant or attorney.
A corporate employee may also be a shareholder, and will also receive a T4PS, a statement of employee profit sharing plan allocations and payments, if the corporation makes such payments. Both are subject to income tax, with specific additional rules.
Types of Tax in Canada
There are three basic classes of tax throughout Canada. They include:
- Income tax, on wages and other types of income. Primary categories of other income include funds earned through sale or rental of a home or other property, funds from a business or professional enterprise, capital gains on investment, dividend and interest income, and specific income from other sources as defined in the tax code.
- Sales tax, including the Goods and Services Tax known as GST or Harmonized Sales Tax (HST). In addition, individual provinces levy sales tax (PST) in varying amounts;
- Property taxes, levied by local governments, are charged based on current value of land and/or improvements, whether residential, commercial or agricultural.
Tax law, tax planning, and tax reporting are complicated. Questions about anything other than basic information is best left up to trained tax professionals or addressed to government officials who have the final say about tax regulations.
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Careful planning as to when and how to issue dividends can ultimately reduce the amount of tax an individual pays.
What is the purpose of a T5 statement?
The purpose of a T5 statement is to tell you how much you have earned from investments. That includes interest, dividends, and royalties. Armed with these documents, you can accurately notify the CRA of how much you have earned in investment income. Contact us if you need help understanding the information your T5s contain and collating them for your tax return.
What’s the difference between eligible and ineligible dividends under Canadian tax law?
The main difference between eligible and ineligible dividends under Canadian tax law is the rate of tax you pay on them. Eligible dividends are grossed up by 138% and ineligible dividends are grossed up by 125%. Carrying out those calculations gives you the taxable income for each type of dividend. You can then use your income tax bracket percentage to calculate the amount of tax you owe for each dividend type.
Are capital dividends taxed the same way as corporate dividends?
In Canada, capital dividends and corporate dividends are taxed differently. The tax has to be paid on corporate dividends by the individuals that receive them-Whereas it is possible for capital dividends when structured properly to be free of income tax. A member of the Rotfleisch and Samulovitch P.C team can assist you in interpreting tax law, so capital dividends can be used in the most advantageous way.