In Canada, all sources of income have to be disclosed in your tax returns, be it from your salary, business/side hustle, investments, or property sale. Each of these incomes is taxed differently. In stock market investments, you earn income through dividends and capital appreciation from selling shares/ETFs at a higher price. A company gives dividends to its shareholders from its after-tax profit. Yet, the dividend is taxable in the hands of shareholders. However, the Canada Revenue Agency (CRA) only gives a non-refundable Federal Dividend Tax Credit to individuals on their dividend income.
How is Dividend Taxed in Canada?
The tax on dividends is paid partially by companies and partially by individuals who receive it. To ensure both parties are not double taxed, the CRA allows individuals to deduct the Federal dividend tax credit from their total taxable dividend income.
Since you receive the dividend after the company has paid its tax, the CRA requires you to gross up the dividend income to arrive at the total taxable value. Now that you have the total taxable dividend, you deduct the federal tax credit from your tax bill. The credit is the tax the corporation already paid on your dividends.
Since it is a non-refundable tax credit, you can avail yourself of the credit amount till your tax bill is $0. If more tax credit is available, it goes unused since it is non-refundable.
Similarly, there is a provincial dividend tax credit, and it works in the same way as the federal dividend tax credit. There are three different types of dividends, and each is taxed differently.
Types of Dividends
Canadian corporations classify the dividends based on the amount of corporate tax they pay.
Eligible dividends are those where the corporation has paid a higher tax rate. If your dividend is eligible, you must add back 38% of your received dividend and deduct 15.0198% from the gross taxable amount as a federal dividend tax credit.
Other than eligible dividends, there are those where the corporation has paid a lower tax rate. Suppose your dividend is classified as other than eligible. In that case, you must add 15% to the dividend you received and then deduct 9.0301% from the gross taxable amount as a federal dividend tax credit.
Foreign dividends are dividends paid by foreign corporations to Canadian shareholders. Such dividends do not qualify for the Canada dividend tax credits. You must pay full tax on the dividend amount from foreign companies.
Computation of Federal Dividend Tax Credit
Let’s understand the taxation of dividend income with an example. Katherine earned $100 in eligible dividends and $200 in other-than-eligible dividends from her investments in two Canadian corporations. She falls under the 20.5% tax bracket.
Step 1: Calculate the gross taxable amount
Eligible gross dividend is $138 ($100 x 1.38)
Other than the eligible gross dividend is $230 ($200 x 1.15)
The total taxable dividend income is $368.
She will report this total taxable dividend on line 12000 and line 12010 of her income tax return.
Since her effective tax rate is 20.5%, she would have had to pay $75.44 federal tax on this income.
Step 2: Deduct the federal dividend tax credit
However, she can deduct the tax paid by the corporations using the federal dividend tax credit.
Eligible dividend credit is $20.73 = ($138 x 0.150198)
Other than eligible dividend credit is $20.77 ($230 x 0.090301)
The total federal dividend tax credit is $41.49.
This credit amount will appear on her T5, T4PS, T3, or T5013 slips.
She will pay $33.95 ($75.44 – $41.49) federal tax on the $300 dividend she received.
Katherine must claim the tax credit on Line 425 on Schedule 1 of her federal income tax return to ensure she gets the tax credit. For provincial credit, she will have to fill out Form 428. Once she files her income taxes, the tax amount will be adjusted for credits.
If Katherine received the above dividends from her investments through the Tax-Free Savings Accounts, the dividends would be exempt, and she wouldn’t have to report them in her tax filings.
The federal dividend tax credit is just one of the many tax credits available to Canadians. These calculations can get overwhelming towards the end of the year, and you might miss out on some of the tax credits available to you.
Contact McCay Duff LLP in Ottawa to Help You with Taxes
A skilled accountant can file taxes on your behalf, complete all the necessary forms, and compute tax credits and deductions. They are well-versed in the different tax benefits and the tax treatment of various types of income. To learn how McCay Duff LLP can provide you with tax filing and tax planning services, contact us online or by telephone at 613-236-2367.
