If you receive a taxable dividend from a Canadian corporation, you will normally be entitled to the dividend tax credit (“DTC”) in respect of the dividend. The purpose of the DTC, along with the gross-up mechanism discussed below, is to provide you with a credit that reflects the income tax presumed to have been paid by the corporation on the income from which the dividend was paid.
In other words, because the dividend is paid out of the corporation’s after-tax income, the DTC is meant to prevent double taxation.
There are two sets of DTC and gross-up rates, depending on the type of dividend. It will be either an “eligible dividend” or a non-eligible dividend.
In general terms, a non-eligible dividend is one received from a Canadian-controlled private corporation (CCPC) out of its business income that was subject to the small business corporate tax rate (applicable to first $500,000 of active business income per year). This corporate rate is lower than the general corporate tax rate.
An eligible dividend is generally paid from a corporation whose income was subject to the general corporate tax rate rather than the small business rate. The corporation paying you the dividend must notify you whether it is an eligible dividend or not. This is done on the T5 slip; different boxes are used for eligible dividends and other dividends.
Because of the two different corporate tax rates, different DTCs are used to reflect the amount of tax paid by the corporation. As noted, the DTC mechanism is meant to alleviate the double tax that would otherwise be paid by you and the corporation combined.
Amount of DTC and gross-up
For eligible dividends, the federal gross-up amount is 38% of the dividend, and the DTC is 6/11 of the gross-up amount or 15.02% of the entire grossed-up dividend (6/11 x 0.38 / 1.38).
For 2015 (on the return you may be filing now in April 2016), the federal gross-up for non-eligible dividends was 18% of the dividend. Due to reductions in the small business corporate tax rates over the next four years, the gross-up is 17% of the dividend for 2016 and 2017, 16% for 2018, and 15% for 2019. The corresponding DTC rates will be: 21/29 of the gross-up amount for 2016; 20/29 for 2017 and 2018; and 9/13 after 2018.
The provinces also have gross-up and DTC amounts for provincial tax purposes, which vary from province to province.
Owing to the gross-up / DTC mechanism, an individual can receive a significant amount of dividends without paying much or any tax, particularly in the case of eligible dividends.
Example with eligible dividend
John is 20 years old. In 2016, his only source of income is $50,000 of eligible dividends from a family corporation.
John will report $50,000 plus the 38% gross up in income, resulting in net income and taxable income of $69,000 for 2016. On this amount, his initial federal tax will be $9,933 after the basic personal tax credit.
The federal DTC will equal 6/11 x $19,000, or $10,363. Therefore, John’s net federal income tax will be nil. Unfortunately, the excess DTC is not refundable. The amount of provincial tax will depend on the particular province, but will similarly be either nil or a fairly low amount.