What is eligible dividend in Canada?

To read Chapter 1, click below:

Chapter 1: Comprehensive guide to dividend taxes in Canada

In the previous chapter we understood all the details about dividends and how do they work in Canada. In this chapter we will discuss in details about eligible dividends.

Dividends represent the distributions made to investors from a company's profits. Among these dividends, some are categorized as eligible, while others are termed ordinary or ineligible dividends.

There are two types of dividends – eligible and non-eligible.  An eligible dividend is essentially a dividend that a corporation designates as eligible. The category of dividends you obtain can affect your tax return.

A corporation can classify a dividend as eligible by providing written notification to each recipient of the dividend, enabling individuals to claim the corresponding gross-up and DTC benefits. In cases where a corporation has numerous shareholders, like a publicly traded company, it can communicate the eligible dividend status through its website or a press release.

GRIP Accounts

The General Rate Income Pool (GRIP) is a concept in Canadian tax law. It is a notional account that corporations use to keep track of certain investment income, such as eligible dividends received from other Canadian corporations. The purpose of GRIP is to help corporations allocate dividends to their shareholders in a tax-efficient manner. The GRIP balance represents the amount of eligible dividends a corporation has received and retained, on which it has already paid corporate income tax.

When a corporation pays dividends to its shareholders, it can use the GRIP balance to pay out eligible dividends to its shareholders. These eligible dividends are generally taxed at a lower rate in the hands of the shareholders compared to other forms of income. In short, the General Rate Income Pool (GRIP) allows Canadian corporations to distribute eligible dividends to their shareholders in a tax-efficient manner by utilizing the balance of eligible dividends they have received and retained. This helps minimize the overall tax liability for both the corporation and its shareholders.

Notification requirements

A corporation is obligated to inform you of its intention to distribute eligible dividends. This notification can take various forms, such as a written letter or a cheque stub explicitly designating the dividend as eligible. Some public corporations consider all their dividends as eligible unless stated otherwise, which is an acceptable notification method. Additionally, the Canada Revenue Agency (CRA) recognizes other notification methods, including posting information on the corporation's website, including details in quarterly or annual reports, and communicating through shareholder newsletters or other publications.

Ideally corporations should be issuing T5 slips to their shareholders which should be included in their tax return. The information from the T5 slip will help individuals while they are filing their taxes.

Gross-ups and dividend income

Both eligible and ineligible dividends require you to include a gross-up rate on your tax return. A gross-up represents an extra amount added to compensate for taxes. As of 2013, the gross-up rate for eligible dividends stands at 38 percent.

Impact of eligible dividends on tax return

Eligible dividends can have a significant impact on your tax return in Canada, typically in a favorable way. Here's how eligible dividends can affect your tax return –

• Lower Tax Rates: Eligible dividends are subject to lower tax rates compared to other types of income, such as interest or employment income. These lower tax rates are designed to encourage investment in Canadian corporations and can result in a reduced tax liability.
• Dividend Tax Credit (DTC): When you receive eligible dividends, you are eligible for the dividend tax credit (DTC). The DTC is a non-refundable tax credit that further reduces the amount of tax you owe on your dividend income. The credit is calculated based on the grossed-up amount of the dividend income.
• Gross-Up and Tax Credit: When you report eligible dividends on your tax return, you first include a grossed-up amount, which is higher than the actual dividend you received. The tax credit is then applied to this grossed-up amount. While this may appear as a higher income on your return, the tax credit effectively offsets a portion of the tax owed, resulting in a lower overall tax liability.
• Income Splitting: Eligible dividends can be an effective way to split income with a spouse or common-law partner. If your spouse or partner is in a lower tax bracket, they may pay less tax on eligible dividends received, leading to overall tax savings for your household.
• Overall Tax Planning: Incorporating eligible dividends into your overall tax planning strategy can help you reduce your tax burden. You can optimize your investments to take advantage of the favorable tax treatment of eligible dividends, potentially resulting in significant tax savings.