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Dividend Tax Credit

What is the Dividend Tax Credit?

The dividend tax credit is the amount that an individual is permitted to apply against his or her tax liability on the grossed-up portion of dividends paid out by corporations. The idea behind the tax credit is to offset double taxation, since the dividends received were distributed from a corporation’s after-tax dollars and are then being taxed again at the recipient’s marginal tax rate.

How are Dividends Grossed-Up?

Dividends are classified as either eligible or non-eligible. In order to be classified as eligible, the corporation paying the dividend must designate the dividend as eligible. The Canada Revenue Agency (CRA) decides what the gross-up percentage will be. In 2018, eligible and non-eligible dividends are to be grossed-up by 38% and 16%, respectively. For example, if an investor receives $50 in dividends, the grossed-up amount will be $69 for eligible dividends and $58 for non-eligible dividends. This grossed-up value will then be included under taxable income on the taxpayer’s income tax form.

How the Dividend Tax Credit Benefits You

Let’s walk through an example to fully understand how the Dividend Tax Credit benefits you. Let’s assume that you received $500 in eligible dividends this year, and your marginal tax rate is 30%.

Option A:Taxed directly on dividend earnings. If no dividend tax credit were applied.
 

DividendRateTax Payable
5000.3150


As you can see above, you would owe the government $150 in taxes, assuming a tax rate of 30% ($500 x .30 = $150).

Option B:Benefit from Dividend Tax Credit.

The tables below show your new tax liability, accounting for the dividend tax credit.

DividendGross-Up MultiplierTaxable IncomeTax RateTax Payable
5001.386900.3207

 

DividendGross-Up MultiplierTaxable IncomeTax Credit %Tax Credit $
5001.3869015.0198%103.64

 

Tax Payable - Tax Credit $ =103.36
(New Tax Liability)


As we can see, our tax liability is only $103.36 in this scenario, compared to $150 under option A. In option B, we started out with the same $500 dividend. The first step was to gross-up the $500 dividend by 38% ($500 x 1.38 = $690). $690 would be recorded as earned income for tax purposes. With a marginal tax rate of 30%, tax payable comes out to be $207 before the tax credit is applied ($690 x .30 = $207).

The tax credit as a percentage of taxable dividends is just above 15%. By applying 15.0198% to the grossed-up dividend value, you end up with $103.64 ($690 x .150198 = $103.64). This is your dividend tax credit. The final step is to subtract $103.64 from $207, resulting in a final tax liability of $103.36. Therefore, the dividend tax credit resulted in a tax reduction of $46.64 ($150 - $103.36 = $46.64).

It is important to note that the dividend tax credit does not apply to dividends received from foreign corporations. As a result, you will pay greater taxes on foreign dividends than you will on domestic ones.

Sources:

https://www.investopedia.com/terms/d/dividendtaxcredit.asp
https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-425-federal-dividend-tax-credit.html
https://turbotax.intuit.ca/tips/the-federal-dividend-tax-credit-in-canada-332

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