With the turn of the calendar to 2010, we also turned the page to the next chapter in the ongoing evolution of Canadian dividend taxation.
The year 2009 was the low-water mark for eligible dividend taxation, with all provinces and territories set to see increased effective rates as we move toward 2012.
Integration model recap
The tax integration model is a mechanism used to eliminate potential double taxation on income earned in a corporation, followed by a dividend distribution to a shareholder.
The dividend gross-up emulates the pre-tax value of the income to the corporation
The shareholder calculates tax owing based on the grossed-up dividend
The dividend tax credit is applied to reduce this preliminary tax liability by the estimated tax already paid by the corporation
Since 2006, Canadian dividends have been distinguished as “ineligible,” generated out of income where the small business corporate rate has been applied, and “eligible.” Though eligible dividends can also be generated out of small business corporations, most taxpayers would receive them via portfolio investments.
Adjustments for 2010
Beginning in 2010, both the federal gross-up and tax credit rates applying to eligible dividends will be adjusted downward:
Year 2009 2010 2011 2012
Gross-up 45% 44% 41% 38%
Tax credit* 19% 18% 16.5% 15%
* These percentages are approximate; Actual calculations use fractions
The federal gross-up also applies in calculating provincial/territorial gross tax due, though somewhat indirectly in Quebec. Each province and territory independently sets its own dividend tax credit to use in determining provincial/territorial tax liability.
The net effect of the federal adjustments and provincial/territorial coordination is that the effective rate on dividends will increase in 2010, except in New Brunswick where the government is collapsing the number of brackets and reducing rates as part of an overhaul of the system leading up to 2012.
Considerations for taxpayers below the top bracket
It is important to understand that the integration model is based on the shareholder being at top marginal tax rate, and that at lower income levels the effective rate on dividends is also lower. For example, at the $60,000 income level the average federal-provincial combined rate is at or near 30%, whereas the effective rate on eligible dividends is at or below the single-digit threshold.
While potential clawbacks have to be factored in, particularly for senior-aged investors, clearly dividend-producing investments continue to warrant consideration and inclusion in a tax-informed investment portfolio, even with these recent changes.