Dividends are profits you receive from your share of the ownership in a corporation, through your purchase of stock or investments in mutual funds. Dividends are considered taxable income, but in Canada, a taxpayer can claim a dividend tax credit on dividends received from taxable Canadian corporations. That effectively reduces the taxpayer's tax obligation.
Dividends come in two types: eligible dividends and other than eligible dividends. The amount of all dividends received must be reported on your Canadian tax return and added to taxable income.
Dividends are shown on a variety of slips depending on their source. For ordinary Canadians who have investments in stock or mutual funds, the most common slip with dividend information will be the T5 - Statement of Investment Income. Other slips with dividend information will be the T3 (Trust Income), T4PS (Employee Profit Sharing Plans), and T5013 (Partnership Income).
Information slips will show the taxable amount of dividends from taxable Canadian corporations. The taxpayer calculates his taxes payable by including all dividends to his other taxable income. Dividends received from taxable Canadian corporations qualify for the dividend tax credit. This tax credit is subtracted from the amount of tax payable. The federal tax credit is 18.9655 percent of the taxable amount of eligible dividends and 13.3333 percent of the taxable amount of other than eligible dividends. Foreign dividends do not qualify for the dividend tax credit. For the provincial dividend tax credit, the taxpayer must complete the dividend tax credit calculation in the provincial worksheet corresponding to his province of residence.
If no information slip was received, the taxpayer must calculate the taxable amount of dividends received. Multiply the amount of other than eligible dividends received by 125 percent, and multiply the amount of eligible dividends received by 145 percent. Those amounts, and not the actual amounts of dividends received, will be included in taxable income.
The dividend tax credit means that taxable Canadian dividends are effectively taxed at a lower rate than regular employment income and interest income. Consider a taxpayer with $10,000 of other than eligible dividends for the year. The taxable amount of those dividends is $12,500 (multiply by 125 percent), resulting in an approximate amount of tax payable of $5,000 assuming a 40 percent marginal tax rate. When the taxpayer applies the federal tax credit, his tax is reduced by $1,666 (13.33 percent times $12,500) to $3,334. His tax rate on that $10,000 dividend is therefore 33.34 percent ($3,334 divided by $10,000), whereas his marginal tax rate on income is 40 percent.