Dividend Tax Credit 101
I’ve known for some time now that I get a tax-break by investing in Canadian dividend paying stocks owned outside registered accounts like my Registered Retirement Savings Plan (RRSP) and my Tax Free Savings Account (TFSA). For today’s post, I’ll shed some light on that.
This blogpost will focus on the dividend tax credit (DTC) for eligible dividends received from taxable Canadian corporations.
In the future I might cover the “other than eligible dividends”, there are other calculations and tax rules for that.
Step 1 – Eligible dividend income earned by investors needs to be multiplied by the dividend gross-up for the tax year. Every year at tax time we have to “gross-up” dividends paid.
We do this because:
- the government tells us so – ha :), and
- the dividends we receive originally came from company earnings. Companies pay taxes on their earnings, just like you and me.
For dividend paying companies dividends come to us from after-tax profits.
Investors who hold Canadian dividend paying stocks get to offset the taxes already paid by the company in non-registered accounts. CRA basically subsidizes dividend investors for the tax the corporation already paid on dividends.
For our tax return, personal tax return, financial institutions are required to “gross-up” dividends for us, they will do this on T3 and T5 slips. You can find out what the dividend gross-up is each year on CRA’s site.
Step 2 – With the “grossed-up” dividend income figure I now apply my marginal tax rate.
As you probably know these tax rates vary depending upon where you live.
I live in Ontario so thanks to my friends at TaxTips.ca I can calculate my taxes payable.
Step 3 – Now I get to apply the dividend tax credit.
Thankfully my province chips in as well.
Different provinces have different dividend tax credits for eligible dividends.
For the last tax year, at the time of this post, Ontario provided a dividend tax credit of 6.4%.
A simplified example:
- Let’s say I earned $1,000 in eligible dividends in 2013. The gross-up for that tax year was 38%. The grossed-up dividend income amount was $1,380.
- Let’s say my marginal tax rate in Ontario in 2013 was 31.15%. So, that’s about $430 in taxes payable before the DTC is applied.
- The federal dividend tax credit was 15.02%.
- The provincial dividend tax credit was 6.4% (I live in Ontario).
Each provincial dividend tax credit gets applied in addition to the federal dividend tax credit, so we’ve got 21.42% to apply in credits.
Applying this amount to the grossed-up dividend total of $1,380 and I get a total dividend tax credit of $295.60.
My taxes payable on this $1,000 dividend income are no longer $430 but just $134.40 ($430-$295.60).
Dividends are very tax efficient
The good news is, assuming you have no other income to report, dividend income is VERY tax efficient – more so than capital gains up to about $50,000 in income.
You actually pay no tax!
Source: Taxtips.ca – current to the time of this post.
This is just one quick example, but I hope it illustrates a few points when it comes to investing in Canadian dividend paying stocks in non-registered accounts:
- With the DTC in place, you’re going to pay some tax.
- Buying and holding Canadian dividend paying stocks makes sense for me, in my non-registered account, over any fixed-income investments like bonds or GICs thanks to the DTC.
- Tax rates are lower on Canadian dividend income than many other forms of income, except capital gains, so again it makes sense I will buy and hold Canadian companies that pay steady dividends in this account for the foreseeable future.
- If you buy and hold your Canadian dividend paying stocks in a registered account like an RRSP or TFSA, the DTC does not apply. You are already getting some form of tax-break inside these accounts.
Question: Are dividends of Canadian companies purchased on a U.S. exchange with U.S. dollars eligible for the dividend tax credit?
In fact, many Canadian companies – including banks, railroads, pipelines, telecoms, insurers and utilities – are interlisted on a U.S. exchange such as the NYSE or Nasdaq. It actually doesn’t matter if the Canadian company’s dividends are purchased by you on the TSX or the NYSE, you’ll get DTC either way.
You can get U.S. dollars from Canadian dividend paying stocks!
If you aren’t sure whether a company’s dividends qualify for the DTC, in a taxable account, then contact the stock company’s investor relations department.
Personally, I tend to only buy my Canadian shares in CDN money.
Sure, you can always buy shares on the Canadian-side and ask your broker to “journal” the shares to the U.S. side of your account, or vice-versa, but that seems like a lot unnecessary work.
If you leave the shares on the U.S. side, your dividends will usually be paid in U.S. dollars.
What’s your take on the Dividend Tax Credit?
Wait so if I earn 100k pay check and pay my regular taxes but have a million dollars in a non registered account with one canadian stock earning 4%($40,000) I will pay no tax on that 40k dividend?!
If you have no other income to report, if you earn up to $50,000 in a taxable account, and own CDN dividend paying stocks and take advantage of the CDN dividend tax credit – then yes, you pay $0 income tax.
In your example below, you used 6.4% as the Ontario provincial tax credit. Based on the 2014 figures from taxtips – http://www.taxtips.ca/dtc/enhanceddtc/enhanceddtcrates.htm, is the updated percentage 10%? Am I reading this right?
For the 2012 and 2013 tax years, in Ontario, it was 6.4%. Each provincial dividend tax credit gets applied in addition to the federal dividend tax credit. For this 2014 tax year, my understanding is the DTC to be applied will be 15.02% + 10% = 25.02% for folks in Ontario.
The reason for the favourable taxation for investors is because dividends are paid with after-tax dollars from a corporation, whereas interest paid is deducted from income before arriving at taxable income. Since dividends are already taxed twice, the DTC was put in place to alleviate tax pain so investors aren’t turned off by dividend paying stocks.
Thanks for the comment Brian – correct – dividends come to us (investors) from after-tax profits. Investors who hold Canadian dividend paying stocks get to offset the taxes already paid by the company in non-registered accounts. CRA basically subsidizes dividend investors for the tax the corporation already paid on dividends.
I mostly invest within my RRSP and TFSA, so I won’t have to worry so much about this, except I do have a very small amount (about $1000) in a non-registered account so I’ll have to look at this next year. Thanks for the information.
All good Daisy!! Eventually, you’ll want to take advantage of this after your TFSA and RRSP are maxed out.
As a companion to this post, you can basically earn up to $50,000 in dividends and pay only $200 in taxes — see post here: How to pay less than $200 in taxes for $50,000 in income
All good reasons to buy dividend paying stocks (assuming the capital will appreciate as well).
Dividends are also how I take my company salary instead of being an employee. 🙂
Smart to take your company salary using dividends. A great way to run a company.