Personal Finance

Impact of credits varies, depending on where you live.
By Matthew Elder | 28/09/10

What's an investor who needs ongoing income to do? Interest rates and bond yields have been at rock-bottom levels for years, and income trusts have had the tax-break rug pulled out from under them. The answer, for many, is a return to dividends.

About the Author
Matthew Elder is Principal of Sensible Communications, a Toronto-based communications consultancy specializing in the financial services industry. He has more than 30 years' experience in financial journalism as an executive, editor, columnist and reporter. He is a former Vice President, Content & Editorial of Morningstar Canada. Previously, he was an editor and columnist at the Financial Post and The Gazette in Montreal.

This type of income has been a mainstay for investors for ages. Profitable companies often share their earnings with shareholders. If the proceeds aren't always lavish, they tend to be steady, with usually reliable cash payments made each fiscal quarter.

In addition to being a source of regular income, dividends are taxed at a more favourable rate than are interest and most other types of income due to the tax credits that they generate for their recipients. This is because the taxation rules assume that a corporation had already paid tax on the dividend income it has distributed to shareholders.

During much of the new century's first decade, individuals in search of regular investment income walked away from dividend-paying stocks in favour of income trusts and their even more beneficial tax status. But in 2006 the rules were changed so that income paid out to investors from income trusts would be taxed at the same rate as dividend income. As a result, an increasing number of businesses that had converted from corporations to income trusts are returning to traditional dividend-paying corporation status.

Investors typically receive dividends from publicly traded corporations. In some cases, investors in private corporations also receive dividends. The latter are taxed more heavily than the former. In either case, the companies must meet certain criteria -- the most important being that they are Canadian-based -- to qualify for the dividend tax credit.

There's no tax advantage in receiving dividends from foreign-based companies. These dividends are taxed at the highest marginal rate, just like employment and interest income.

To achieve what governments believe to be a fair level of taxation in investors' hands, individual investors report a "grossed-up" amount of Canadian dividends received. This inflated amount is supposed to represent the amount of pre-tax income that the dividend-paying corporation has earned. The taxpayer then claims a tax credit to offset the tax the corporation is presumed to have paid.

It's worth noting that federal and provincial governments are lowering the amounts of the dividend gross-up and the tax credit. For example, the federal dividend gross-up for public companies was at 45% until this year, when it fell to 44%.

It drops to 41% for 2011 and 38% in 2012. The federal dividend tax credit simultaneously drops to 18% from the previous 19%, and to 16.4% and 15% over the next two years. The net effect will be slightly higher taxation of dividend income in investors' hands.

The actual rate at which dividend income is taxed in the investor's hands varies depending on the province. For higher-income individuals, Alberta offers the best deal on dividend taxation.

An Alberta resident with $100,000 of taxable income, for example, sees his dividend income from Canadian public companies taxed at 11.6%, while a $200,000 earner would be taxed at 15.9%. In Ontario, by contrast, the rates are 22.3% and 26.6% respectively. In Quebec, where taxes are higher still, the corresponding rates are 27.1% for $100,000 in taxable income and 30.7% for $200,000 in taxable income. (See table.)

For individuals with lower taxable incomes, British Columbia offers the best deal on dividend income. A $50,000 earner pays tax at 1.3% on dividends received from Canadian public comp, while the rate for a $75,000 earner is 5.3%. In Ontario, those rates are, respectively, 9.8% and 14%, and in Quebec they're 16.5% at both these income thresholds.

Note that, as with other non-refundable tax credits, the dividend tax credit is worthless if you have no taxable income. If you or your spouse is in this situation, you may elect to transfer the amount of dividend income from the lower-income spouse's income-tax return to that of the higher-income person.

While this would cause the dividend income to probably be taxed at a higher rate, it will prevent erosion of the spousal tax credit. The latter would be reduced by the amount of dividend and any other income received in the lower-income spouse's hands.

2010 Tax rates on dividend income
Taxable incomeB.C.Alta.Ont.Sask.Man.

Taxable incomeQue.N.S.N.B.P.E.I.Nfld. & Lab.
Note: Combined federal-provincial rates for dividends from Canadian public corporations

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