Tax treatment of Canadian dividend paying stocks

Tax treatment of Canadian dividend paying stocks

I got this email in my inbox recently:

You write about Dividend Reinvestment Plans (DRIPs) often.  I wonder if you would discuss the beneficial tax treatment of dividends and DRIPs.  I’m not sure everyone understands the tax issues or implications.

Thanks for your comments and questions.  Let’s get to my answers.

Regarding my dividend investing strategy

You might already know by now, I’m a hybrid investor.  I own many Canadian dividend paying stocks for cash flow/income and I own a few ETFs for long-term growth.  Most of the index investing I do is inside my RRSP account with U.S.-listed ETFs.

Back to the stocks…my portfolio consists of close to 40 Canadian companies.  I figure that’s enough.  Just like the holdings of many popular Canadian ETFs, I own a mixture of the following (and likely will for the foreseeable future for passive income):

  • 5-7 Canadian banks
  • 3 life insurance companies
  • A few pipeline companies
  • 3-4 telecommunications companies
  • 4-5 utility companies
  • 1-2 industrial companies
  • 3-5 energy companies
  • 6-10 Real Estate Investment Trusts (REITs).

You can read about this consideration – using Canadian dividend paying stocks instead of Canadian ETFs for portfolio here.

Tax issues with Canadian dividend paying stocks?

There are some things to be mindful of.

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).  You should too.

Here’s the thing – companies pay taxes on their earnings, just like you and me.  For dividend paying companies those 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.

This is performed by a “gross-up” of eligible and non-eligible dividends.

A simplified example for eligible dividends:

  • Let’s say I earned $1,000 in eligible dividends. The CRA gross-up is 38%.   The grossed-up dividend income is $1,380.
  • Let’s say my marginal tax rate in Ontario is 40%. That’s about $552 in taxes payable before the Dividend Tax Credit (DTC) is applied.
  • Now for the DTC – there is a federal and a provincial tax credit available to me. The DTC provides a credit for about the same amount of tax the company has already paid.  I love using TaxTips.ca as my source for this (no affiliation).
  • The federal DTC is 15.02% of the grossed-up dividend.
  • Provinces also kick in their own DTC and I live in Ontario. The DTC in Ontario is 10% of the grossed-up dividend.
  • The combined federal and provincial DTC for me is 25.02%
  • Applying this percentage to the grossed-up dividend total of $1,380 and I get a total dividend tax credit of about $345.

That’s a nice credit but it’s really just tax integration.

The lower my marginal tax rate is however, the lower the taxes payable before the DTC is applied AND the better the tax treatment after the DTC is applied.  Effectively, if you had no other income other than income from Canadian dividend paying stocks in a taxable account, about less than $50,000 in income actually, you wouldn’t pay any income taxes.

That’s very nice.

So, for investors holding Canadian dividend paying stocks inside taxable accounts – you are eligible for the Canadian dividend tax credit.  U.S. stocks are not and you can read more about U.S. stock tax treatment here.  This makes the following “standard advice” for direct stock ownership as follows:

  • Dividends from U.S. stocks are taxed in Canada like interest income.
  • Capital gains on U.S. stocks are taxed favourably like Canadian stocks. Consider holding U.S. stocks that pay little to no dividends in a taxable account.
  • Consider holding U.S. stocks that pay dividends inside your RRSP.

Implications with Dividend Reinvestment Plans (DRIPs)?

There are a few.  I love DRIPs because they help keep my investing activities on autopilot.  Money comes in, gets reinvested, rinse-and-repeat.  You can read about a long list of pros and cons with DRIPs here.

However, if you’re investing in Canadian dividend paying stocks for income like I am, sometimes in a taxable account outside your TFSA or RRSP, you’ll need to keep track of your Adjusted Cost Base (ACB).

What the heck is that?

Adjusted Cost Base (ACB) is a calculation used to determine the cost of an investment for tax purposes.  It’s really only relevant to taxable accounts because you already know the TFSA is a tax-free account, funded by after-tax dollars.  You also already know the RRSP is a tax-deferred account.

When you sell an asset, like a Canadian dividend paying stock, you may have a capital gain or a capital loss.  Running DRIPs for long periods of time in a taxable account can complicate your ACB since additional, commission-free, reinvested dividends every month or quarter essentially add new stock purchases to your portfolio.  These purchases need to be tracked and included in your ACB.

Thankfully there are a number of spreadsheets and even free online tools you can use for ACB – this is one of my favourites (no affiliation) at adjustedcostbase.ca.

Regarding my dividend investing strategy

I currently DRIP most of my Canadian companies.  Most of the reinvesting work takes place inside my TFSA although some DRIPs do occur in a taxable account.  This means I can take advantage of the Dividend Tax Credit but I also must keep track of my Adjusted Cost Base in this taxable account.  Over time, I will continue to hold a handful of Canadian dividend paying stocks in a taxable account, deferring capital gains for as long as I can.  I will also earn a good portion of my Canadian dividends tax-free (thanks TFSA).

Thanks to readers for these comments and questions. Keep them coming.

My name is Mark Seed and I'm the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I've grown our portfolio to over $700,000 now - but there's more work to do! Our next big goal is to own a $1 million investment portfolio for an early retirement. Subscribe and join the journey!

18 Responses to "Tax treatment of Canadian dividend paying stocks"

  1. It’s my first year of investing. Now that I have set up my investments my mind has turned to thinking about taxes.

    1. Does a standard tax program (ex. Turbotax) complete these calculations automatically? Assuming I provide it with the right numbers?

    2. I figure brokerages (Questrade, RBC Direct) will provide me with some tax forms. Do these forms automatically calculate my capital gains amount, dividend amounts, other necessary info?

    Thanks for your help.

    Reply
    1. Most brokerages will keep track of your capital gains for informational purposes only. This is not an official number. You must keep track of your adjusted cost base yourself. KEEP ALL YOUR CONFIRMATION SLIPS. The exception to this is if capital gains are made within a mutual fund, then the capital gains are reported on a T3,

      Reply
      1. Great point John. I keep all my tax slips just in case I need to calculate a capital gain or loss. You are correct most brokerages do this and although investors are welcome to use that number, it might not always be accurate.

        Reply
    2. Congrats on investing for now and the future Ryan.

      1. All standard online or software programs, like TurboTax, do your tax calculations automatically based on your data entries. If you keep reading my blog, I’ll likely have a few FREE tax software codes to giveaway in 2017.

      example:
      http://www.myownadvisor.ca/turbotax-giveaway-and-more-great-tax-filing-tips/

      2. Your discount brokerages will provide you with your tax forms. Those tax forms will help you calculate things like eligible dividends, interest earned, etc.

      To avoid unnecessary tax headaches, you should consider organizing your investments this way (see below) to make your investments as tax efficient as possible:
      http://www.myownadvisor.ca/dividends/

      For me…anyhow….

      “In Summary – Asset Location Preferences:
      Non-Registered = Canadian dividend paying stocks.
      TFSAs = Canadian dividend paying stocks and Canadian REITs. .
      RRSPs = U.S. dividend paying stocks and U.S.-listed ETFs.”

      Happy investing,
      Mark

      Reply
  2. Ryan: Great you started saving for your future. Yes, all the tax software programs will calculate your taxes, all you have to do is input the T4’s, T5’s & T3’s. I believe the explanations above and others provided by Mark are to help you decide where the best place is to hold certain types of stocks (for example, hold US stocks in an RRSP or REITS in a TFSA and/or RRSP). Also if your taxable income is less than $40,000 you will pay no taxes on your dividend income.

    Reply
  3. Do not all the online brokerages update your adjusted cost base when you DRIP through them?
    I am away so cannot re-check my records but believe that mine does. I wouldn’t do a DRIP if I had to compute all those numbers.

    Reply
    1. No, that’s the downside, not all brokerages calculate your ACB. Most do though, I believe BMO, TD, Scotia and RY do. I don’t know about CIBC Investor’s Edge or others. For the most part, you can trust the brokerage since they issue your tax forms but when in doubt you need to be sure you can explain anything to CRA.

      I wouldn’t do a synthetic DRIP if my brokerage didn’t track it either so I could at least compare my records 🙂

      Reply
  4. I haven’t set up a DRIP inside my registered accounts just yet, but with respect to my non-registered accounts, dividends I earn are not and will not be set up as a DRIP because of having to calculate the ACB. I simply take the cash and reinvest it myself and one advantage of that is that you decide where to allocate that cost, which means you don’t have to worry about the ACB at all.

    My brokerage is Questrade, and they do synthetic DRIPs, but they do not calculate the ACB, so thats another reason I don’t do it in a non-registered account.

    Reply
  5. Vito, when my son was starting investing (he had almost $100,000!) I suggested Questrade, but I am sorry about that. My husband also has a small account with them and I find them so difficult to use.

    Scotia iTrade has so many features that I just love. Just click onto the stock to add DRIP or take it off is just one of them. They always have your adjusted cost basis shown, too. I also use TD Direct invesring, it is easier for US dollar investments, but otherwise I would close that account as they don’t provide enough info.

    Reply
    1. Thanks Barbara. Yes, some brokerages (beyond Questrade) are great with ACB and the ability to “turn on” or “off” DRIPs. Some (brokerages) are better than others of course; they have different features.

      Reply
  6. Hi Barbara,

    What is it that you find difficult? I actually love their interface, as I find it straightforward meaning more user friendly, and I am by no means an active day trader, just someone who is somewhat starting their investment journey as I imagine most of the readers on this site are. I don’t use Scotia iTrade or TD DI, so I can’t speak for them, but if I had to choose any other brokerage it would probably be with TD.

    Questrade has always been praised for UI and innovation and being that I have been with them since 2012, I can attest to this. Their online chat is great and email response is within a respectable 48 hours. They are definitely one of, if not the cheapest option for online brokerages as well.

    The only thing I do wish that provided is the ACB and although I do have an account set up at adjstedcostbase.ca I haven’t really dived into the site more thoroughly, so it after I do, it might be a mute point.

    Reply
  7. Hey mark I’m new to investing as of dec 2017. I have most of my TFSA locked in terms but once they mature I’ll be movin them over to quest trade to make more money then what the bank offers. I’m into ETFs have lots of stocks but I’m wondering if I should take a large sum of money from my eq bank account to invest in more stocks or just wait until my TFSA account mature? Also I’m wondering if you wouldn’t mind sending me a list of your successfulinvestment portfolio so I could maybe review and possibly piggy back off of.

    Reply
    1. Hey Dustin,

      Thanks for your email. I cannot offer specific investing advice here but I can offer a take on how I manage my TFSA. I use a self-directed TFSA. Stay tuned for a post on Monday about that! In terms of what I own, I hold primarily CDN dividend paying stocks inside my TFSA for income and growth. My holdings are companies you’ll find in these posts/pages:

      https://www.myownadvisor.ca/dividends/

      https://www.myownadvisor.ca/december-2017-dividend-income-update/

      Let me know if you have more questions about what I own and why. I can put up a new blogpost on that potentially. Other than some CDN stocks I try and use low-cost ETFs for investing.

      https://www.myownadvisor.ca/indexing/

      All the best with your investing journey and thanks for being a fan.

      Reply
  8. I am a beginner investor. And would like to have some info about investment portfolios, BEST canadian stocks to buy, info on ETF and which brokerage to go with?
    Thanks

    Reply
    1. Hi Mankirat,

      I cannot offer specific investing advice but I do think for a beginner investor it’s important to educate yourself first. Here are some posts:
      https://www.myownadvisor.ca/saving-investing-resources-newbies/

      https://www.myownadvisor.ca/start-investing-do-these-three-things/

      I should also highlight I have partnerships with some firms, like Bank of Montreal and ModernAdvisor to help you start investing with ETFs. You can read up on the SmartFolio more here including a link to my promotion: You can invest online with BMO and you won’t pay fees on your first $15,000 invested for a year. Make sure you use promo code MYOSF for My Own Advisor’s special offer when opening your BMO SmartFolio account

      https://www.bmo.com/smartfolio/?ecid=af-AFFILSFSDMYOSF1-CSBMO16

      You can invest with ModernAdvisor here – ModernAdvisor risk-free for 30 days with a trial account funded with $1,000 of ModernAdvisor’s money.
      https://www.modernadvisor.ca/#_a_MyOwnAdvisor

      I personally own a collection of CDN dividend paying stocks, some U.S. stocks, and some ETFs for extra diversification. So far, so good.

      Reply
  9. I did not see any software that calculates the tax correctly if the superficial loss rules apply. This could happen if you trade/own the same stocks in both registered and unregistered accounts, and trade frequently.

    Reply

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