When you, as a shareholder, receive business income, this income is known as a dividend income.
Corporations pay corporate income tax on any active business income. So naturally, as a shareholder, you also pay an income tax you make from that corporate.
Since you receive a taxable dividend from the business’ after-tax income, such income might be subject to double taxation.
However, the Canadian income tax system has ways of offsetting this double taxation problem, such as the gross-up and dividend tax credit, which affect eligible and non-eligible dividends. Also, we timely remind you here that you may want to invest in dividend stocks with the help of an online brokerage or a robo advisor where, apart from dividends, you can trade in ETFs, long-term Canadian stocks, best stocks to buy now, or top 5G stocks.
So read on as we’ll explain everything in detail about eligible vs non-eligible dividends.
Dividend Types Under the Canadian Income Tax Act
A dividend is a cash payment or any value transfer from a corporation to its shareholders in its simplest form.
Regardless of what type of dividend you receive from a corporation, it will either be an eligible or non-eligible dividend, which determines the tax rates you, as a shareholder, pay on a dividend earned directly.
At the heart of the Canadian Income Tax Act is the concept of tax integration, which aims to make the tax rates the same from the moment it’s earned as corporate income until it reaches the shareholder’s pocket, regardless of how many levels it passed through before that.
To do this, tax integration is done through a dividend gross-up and a dividend tax credit, which offsets the amount of tax the corporation has already paid on dividends issued from taxable income.
Through these strategies, tax integration can help eliminate any possibility of double taxation. Since the corporation already pays corporate tax on its income then pays its shareholders a dividend out of it, the shareholder would pay a second marginal tax rate on the after-tax dividend.
Because not all corporations are equally large or profitable, a small business pays a lower corporate tax rate than a large one. The distinction is typically made by determining whether the corporation is eligible for a small business deduction or not, which also determines whether the corporation pays you an eligible or a non-eligible dividend.
Now let’s look in more detail at what eligible and non-eligible dividends are by definition. And as a side note, eligibility doesn’t apply to capital dividends, as corporations pay those out of the capital dividend account instead of business income.
What Is an Eligible Dividend?
Larger corporations pay out eligible dividends to their shareholders from a special eligible dividend tax pool balance known as the general rate income pool, or GRIP for short.
These so-called large corporations are either public corporations (see Maple Leaf Food) that don’t qualify for a small business deduction or high-earning private corporations that make more than $500,000.
Anyhow, this means that the corporation pays a higher corporate tax rate on the corporation’s income before it issues you an eligible dividend.
An eligible dividend is more favourable for you, as a receiving shareholder, because it amounts to a lower marginal tax rate than a non-eligible dividend would.
What Is a General Rate Income Pool?
A general rate income pool, or GRIP, represents a special account that contains the corporation’s income that isn’t subject to any alteration, such as a deduction or special taxes.
Companies designate a GRIP account to set aside a sum to be taxed appropriately, then paid as eligible dividends to all its shareholders.
Moreover, a GRIP account balance is grossed-up to reflect corporate income earned, then a dividend tax credit reflects the higher rate of corporate taxes paid.
As per the Canadian Revenue Agency, a corporation’s dividends shouldn’t total an amount that exceeds the GRIP account balance. If it does, then the corporation is subject to a federal corporate tax rate of 20%.
What Is a Non-Eligible Dividend?
Non-eligible dividends, also known as ordinary, regular, or ineligible dividends, are issued by any public or private Canadian corporation that earns under $500,000 and is thus eligible for the small business deduction.
Furthermore, corporations that pay ineligible dividends don’t have to use a GRIP account. Still, their dividends are grossed-up nonetheless, and a lower dividend tax credit is included to reflect the company’s lower corporate tax.
Since a non-eligible dividend tax credit is lower, it means that ineligible dividend tax credits are less favourable for you.
What Are the Gross-Up Rate and Dividend Tax Credit?
We’ve been using the terms gross-up rate and dividend tax credit throughout this article, so let’s clarify a bit more on them.
A gross-up amount is an additional sum of money paid to you alongside a taxable dividend to offset the income tax you pay on after-tax money.
On the other hand, the dividend tax credit is the amount that you apply against your tax liability on the gross-up amount generally received.
Note that gross-up payments and dividend tax credits are only applicable to individuals and not corporations.
Are Non-Eligible Dividends Taxable?
Yes, non-eligible dividends fall under your personal income taxes.
At a federal level, the tax rates on non-eligible dividends range from 6.87% to 27.57%.
In Ontario, the top marginal tax rate is 47.74% for those who earn more than $220,000 per year.
However, this doesn’t necessarily mean you’ll be paying nearly half of your dividend income because of the caveats we mentioned above, namely the gross-up and dividend tax credit.
The Canadian government calculates tax on dividends as a percentage of the dividend you receive, excluding any gross-up amount. For non-eligible dividends, the gross-up rate is 15%.
The tax is also calculated before deducting any dividend tax credits.
For more information on the tax rates in your province or territory, check out the Canadian Tax and Financial Information website.
Who Must Report Eligible vs Non-Eligible Dividends?
The corporation you’re a shareholder in should notify you whether the dividend paid to you is eligible or non-eligible.
As for reporting your income, you’ll have to do it yourself.
You’ll find your dividend on the T3, T4PS, T5, or T5013 statement slip. On your return slip, write the amounts on line 12000 if you’re receiving an eligible dividend or line 12010 if you’re receiving a non-eligible dividend.
If you didn’t receive an information slip from your corporation, you can still complete the return chart. If you received an eligible dividend, multiply the number you received by 138% and write it on line 12000 of your return.
However, if you received a non-eligible dividend, multiply the number you received by 115% and write it on lines 1200 and 12010.
Frequently Asked Questions
How Do I Know if My Dividends Are Eligible?
A business can issue eligible dividends to its shareholders, in which case the business should notify each shareholder of their eligible dividend so they can claim their gross-up rate accordingly or see if dividend tax credit applies.
Are Eligible Dividends More Favorable for a Shareholder?
Yes. A shareholder receiving eligible dividends is subject to more favourable taxes than if they were receiving non-eligible dividends. This is because the corporate tax is higher for larger businesses, so you receive a higher dividend tax credit.
Do Dividends Count as Income in Canada?
Yes. However, in Canada, dividends income is taxed differently compared to interest income. Shareholders in the highest bracket pay a 39% tax, while those earning interest income in the highest bracket pay 53% tax.
Are Dividends Taxed if Reinvested?
Yes, dividends issued are taxed immediately, even if you decide to reinvest them into the business.
What Dividends Are Tax-Free?
As of 2021, a single filing shareholder isn’t taxed if their eligible dividends amount to $49,020 or less, whereas for married shareholders filing jointly, this number is $98,040 or less. This is an increase of $485 and $970, respectively, from last year.
The Bottom Line
We hope we helped you with our guide on eligible vs non-eligible dividends. To recap, eligible dividends are more favourable for you and are paid by larger corporations, while smaller, less-taxed corporations pay ineligible dividends. Moreover, there is a firm system in place that uses gross-up money and dividend tax credit to integrate taxes and avoid double taxation.