Reduced personal tax rate on dividends

Reduced personal tax rate on dividends
by Kevin Keith - 4, 2008

The next time you receive an information slip for investment income, take a look at it closely. If the slip reports dividend income, are you receiving eligible dividends or non-eligible dividends? If you receive eligible dividends, there is likely good news. The government has reduced the effective personal tax rate on these dividends. If you are paying personal tax at the top rate, this reduced effective personal tax rate on eligible dividends can produce tax savings of about 8% on such dividends in 2007. This article may be of interest to you if you receive dividend income or you have a corporation that has the ability to pay eligible dividends to its shareholders.

Eligible dividends vs. non-eligible dividends
Starting in 2006, there are two types of dividends that can be received by individuals and paid by certain corporations. The regular dividends that corporations normally pay are now called non-eligible dividends. The new type of dividends that certain corporations can pay, that are subject to lower effective personal tax rates, are called eligible dividends.

Introduction of eligible dividends
The reason the new eligible dividends were introduced was to eliminate the double taxation of dividends. Until this legislation came into effect, certain corporations were paying a high rate of corporate income tax on their profits. If these corporations subsequently paid a dividend, the shareholders were also required to pay a high rate of personal tax on the dividend income they received from the corporation. In order to "level the playing field" between corporations and other investments - particularly income trusts, this double taxation of income needed to be changed. Now, if the corporation is required to pay a higher rate of tax and subsequently pays a dividend to its shareholders, the individuals now pay a much lower tax on this eligible dividend income. This lower effective tax rate may also entice people to invest their money into shares of corporations because there is a lower effective personal tax rate to be applied to eligible dividend income.

It is important to consider the types of dividends that you are receiving. For example, if the Royal Bank pays you a dividend, it is probably an eligible dividend since the Royal Bank is a public company. Since the Royal Bank paid a higher tax rate on its income, you are receiving a tax break and will pay a lower personal rate of tax on the dividends that you receive. The dividend paid by most publicly traded companies will fit into this category.

Information slip
The new information slip that you receive looks different from before. The slip now has additional boxes that state your eligible dividend information, as well as your non-eligible dividend information.

Corporations paying eligible dividends
Have you considered whether your company is able to pay eligible dividends? Generally, your company is able to pay these eligible dividends if it receives eligible dividend income from a public company or pays tax at the general rate, which is at a higher rate than the small business rate. The dividend income that is received by the shareholders is taxed at a lower effective rate than regular non-eligible dividends.

Requirements of corporations when paying an eligible dividend
Each time an eligible dividend is paid by a corporation, the corporation must designate the dividends that are eligible on the information slips for the shareholders. The corporation must also provide notification that an eligible dividend has been paid. The following are examples on how notification may be provided:

* Identifying eligible dividends through letters to shareholders and dividend cheque stubs

* Where all shareholders are directors of the corporation, a notification in the Minutes.

If you would like more information about whether your corporation is able to pay eligible dividends and how this will help you save on taxes, it is recommended that you talk to an experienced advisor. The calculations to determine the amount of eligible dividends that may be paid to shareholders are complex. There are very strict rules for paying eligible dividends and you want to ensure that you are abiding by these rules and not paying out more eligible dividends than your company is allowed to pay. Many companies who normally pay a bonus to its shareholders in order to reduce taxable income to the small business deduction limit of $400,000 may now wish to pay the higher rate of tax and increase the amount of eligible dividends that will be available to pay because of the lower personal tax rate to shareholders. This is a tax planning strategy that is dependent on you and your company's situation.

KPMG Lethbridge
kkeith@kpmg.ca

Kevin Keith would like to thank Jenny Koba of KPMG for her assistance with writing this article.