Dividend Tax Credit: Definition & Examples
A dividend tax credit (DTC) is a type of credit, or tax break, that is provided to the recipient of a dividend to account for the portion of taxes already paid by the issuing corporation. Simply put, it’s a way to prevent double taxation, since a dividend paid out of a corporation is not deductible from the taxable income of the corporation.
Dividend tax credits are available to anyone who is the recipient of a dividend from a Canadian company. And while they can be available to both Canadian residents and non-residents, each country’s tax laws will vary greatly on the benefits that this kind of tax credit provides.
The credit encourages investment in Canadian companies by making dividends more tax-effective. In this guide, you will find examples of the dividend tax credit in action and more.
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KEY TAKEAWAYS
- Dividend tax credits are a way to ensure fairness in Canadian tax integration. It provides a tax credit for dividends received from investment, while helping to avoid double taxation on corporate income.
- Dividend tax credits are available in many countries, including the United States, Canada, and the United Kingdom.
- Dividend tax credits can encourage investment in companies that pay dividends and can help investors save on taxes.
What is a Dividend Tax Credit?
A dividend tax credit is an amount an investor can use to reduce the taxes they owe on top of the dividend income they received. It is usually a dollar-for-dollar reduction and cannot serve as a tax refund. A dividend tax credit reduces taxes payable, but won’t add money to your refund as with capital gains or losses.
When a company pays a dividend, a dividend tax credit will be automatically attached. Companies may pay eligible or non-eligible dividends depending on whether or not they are over the $500,000 Small Business Limit (SBL). The DTCs on eligible dividends are higher than on non-eligible dividends, as more corporate tax has been paid on retained earnings from which an eligible dividend has been paid.
In BC, corporate income over the SBL of $500,000 is taxed at 27%, while companies under that limit are only taxed at 11%. It should also be noted that the SBL can be lowered if your corporation’s taxable capital exceeds $15M—you are then considered a large corporation and, therefore, will have to pay eligible dividends.
In any case, your broker will provide you with a T5 slip for any and all dividends you receive over the tax year.
How Do You Calculate a Dividend Tax Credit?
To calculate a dividend tax credit, you need to know your marginal tax rate. Your marginal tax rate is the highest rate of tax that you pay on your income. Marginal tax rates can vary greatly across Canada, with BC having more than 20 (11 rates for non-eligible dividends and 11 for eligible dividends) marginal tax rates alone. Do research on your marginal tax rate ahead of time to ensure your calculations are correct.
First, you’ll need to calculate your dividend income with gross-up (an extra sum of money added to an amount to cover income tax that will be owed on it in the future). Suppose your marginal tax rate is at 23.46% for eligible dividends and 37.99% for non-eligible dividends. If you received $100 in eligible dividends and $200 in non-eligible dividends that year, you would add the relevant marginal tax rate to each figure to get your grossed-up amount:
- Eligible dividends: $100 X 1.2346 = $123.46
- Non-eligible dividends: $200 X 1.3799 = $275.98
From here, you can calculate your total taxable amount by adding the two sums:
- 123.46 + 275.98 = 399.44
Therefore, your total taxable amount of dividends to claim on your return would be $399.44. From here, you can calculate the amount of your dividend tax credit. This credit offsets the extra taxation you owe by paying on a grossed-up sum, and can even be advantageous when compared to your marginal tax rate for regular income.
As of now, credit values are at 15.0198% for taxable, eligible dividends, and 9.0301% for non-eligible dividends. So using the grossed-up numbers from the example above, you can calculate your credit with these percentages:
- Eligible dividends: 15.0198% of 123.46 = 18.54
- Non-eligible dividends: 9.0301% of 275.98 = 24.92
- Your total tax credit: 18.54 + 24.92 = 43.46
This means that when it comes time to pay taxes on your dividends, you’ll have a $43.46 credit to offset your owed balance.
Dividend Tax Credit vs Deduction
A deduction reduces the amount of income that is subject to tax. A tax credit, on the other hand, reduces the amount of taxes that you owe. So, a deduction saves you money by reducing your taxable income, while a tax credit saves you money by reducing your tax bill.
How Do I Claim the Dividend Tax Credit?
If you are a Canadian resident, you will claim the dividend tax credit on your annual income tax return on line 40425.
You will need to provide your grossed-up dividends amounts and your tax rate in order to calculate the credit. The easiest way to do this is to use the dividend tax credit calculator on the Canada Revenue Agency website.
What Are the Benefits of the Dividend Tax Credit?
The dividend tax credit has a number of benefits for investors. First, it makes dividends more tax-effective. This means that you can keep more of your investment earnings and have more money to reinvest or spend as you see fit.
Second, the dividend tax credit encourages investment in Canadian companies. This credit applies tax-effective dividends, incentivizing investment in Canadian stocks and mutuals.
Third, the dividend tax credit can provide flexibility in the way you’re paid. Although it won’t save you a significant amount of money to choose to be compensated via dividends (since your company will have already paid all taxes that you would have paid had you been on salary), there can be advantages to a dividend compensation structure. This tax credit means that being paid in dividends has most of the same advantages as salary.
Finally, the dividend tax credit is easy to claim. Simply enter your information into the Canada Revenue Agency’s online calculator to get all the specific numbers you need. Then, claim the dividend tax credit on Line 425 on Schedule 1 of your personal income tax return.
You’ll likely need some relevant forms to provide all this information ,which can (depending on your situation) include:
- T5 Statements of Investment
- T4PS Statement of Employee Profit-Sharing Plan Allocations and Payments
- T3 Statement of Trust Income Allocations and Designations
- T5013 Statement of Partnership Income
Taxes can be a complex process, but features like the dividend tax credit help provide some predictability and balance during the tax season, ensuring fairness and financial balance on your dividends earnings.
Summary
The dividend tax credit is a type of Canadian tax credit that offsets the taxation of earnings from eligible and non-eligible dividends. Although specific information, such as your marginal tax rate, will vary from province to province, the overall process is relatively simple with a foundation of knowledge and proper organization.
FAQs About Dividend Tax Credit
The best way to avoid paying tax on dividends is to invest in a tax-sheltered account, i.e., a registered retirement savings plan (RRSP) or a registered pension plan (RPP).
Dividends earned in these accounts are not subject to taxation.
The eligible dividend tax credit is a Canadian tax credit. As such, it’s available to Canadian investors who hold shares in Canadian corporations and/or Canadian-controlled private corporations (CCPCs).
Dividends on income above the small business dividend (SBD) limit are considered eligible. This income goes into a general rate income pool (or GRIP) account, from which eligible dividends are paid.
Dividends are considered to be income, and they are subject to taxation. However, the tax rates on dividends are usually lower than the tax rates on other types of income.
The current dividend tax credit on eligible dividends is at 20.73%, though this number tends to change from tax year to tax year.
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