Michael Formuziewich

If you own dividend paying companies then you are probably familiar with the “T5 – Statement of Investment Income” which we get each February, one for each company held outside registered accounts. There are three boxes which are used for tax purposes: 1) Box 24 shows the actual amount of dividends received, 2) Box 25 shows the taxable amount of eligible dividends (also known as the dividend gross-up) and 3) Box 26 shows the dividend tax credit (or DTC for short). Upon looking at the T5 you may have wondered about the purpose of the gross-up and DTC.

The dividend gross-up and the DTC were created by the federal government in an attempt to avoid double taxation. A dividend paid by a corporation comes from the corporation’s after-tax money. If the government was to tax you on the actual amount of dividends paid then they would, in effect, be taxing the dividend payment twice – once while it was still at the company and again when you pay taxes on it. To prevent this double taxation the government has devised the convoluted dividend gross up and dividend tax credit (DTC) formula.

First, the dividend is grossed-up by 38%. For instance, if you received $100 of dividend income in 2013 then the grossed-up amount would be $138. The DTC of 15% is then applied to the grossed-up amount. In the above case, the DTC would be $20.70.The grossed-up amount of $138 is included in your taxable income. Federal taxes payable are then calculated based on your taxable income (including employment income, commission income, OAS payments, CPP payments and so forth).If you had no other income of any sort and no tax credits (an unlikely scenario) then your federal tax owing based solely on the $138 grossed-up dividend would be $20.70. The DTC is then applied to reduce your federal tax owing. In the above case, the DTC of $20.70 would cancel the $20.70 federal tax owing.

Each province also has their own DTC, ranging from a low of 6.4% in Ontario to a high of 12% in New Brunswick which is applied against provincial taxes owing. The mechanics work in a similar manner as described above for federal taxes.

A much simpler method would have been for the federal government to simply apply a DTC of 15% against the dividend received; there would be no need for a dividend gross-up or to calculate the DTC based on the grossed-up amount. The function of the gross-up is to push your taxable income higher and move you into a higher tax bracket sooner than if there was no gross-up: if you received a 15% DTC based on the actual amount of dividends you received, then you wouldn’t pay any federal tax until your dividends exceeded $67,216 (this takes into account the basic personal amount of $11,038 for the 2013 tax year) whereas with the dividend gross-up formula you start to owe federal taxes at $48,707. So, what is the rationale for the dividend gross-up? In short, Canada has a “progressive” tax system and our political masters, in their wisdom, decided that taxpayers earning dividend income should start to pay taxes sooner than a simple DTC of 15% would imply.

(The gross up of 38% and the DTC of 15% used in this post are based on large publicly traded corporations. Private corporations have their own gross-up and DTC percentages)

 

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