Dividends are paid from the after-tax income of the corporations to shareholders. Whether you want to withdraw salary from your corporation or pay dividends to yourself, it depends on specific tax situation.
Whether you are opting to withdraw salaries or dividends from a Canadian Controlled Private Corporation (CCPC), because of the integration principle of Canadian tax system taxes paid on either of them approximates the same.
Dividends give an opportunity to defer taxes at a personal level by using timing of issuance of dividend as a tool. Timing of dividend withdrawals directly impact the personal margin tax rates.
Process of Dividend Issuance
Payment of dividend is largely governed by the business acts (or laws) of the jurisdiction in which the corporation is incorporated. Generally, directors of the corporation pass a resolution to issue dividend to shareholders. Corporation must ensure compliance to relevant corporation laws to ensure that they meet solvency test and other corporate procedural requirements.
Filing T5 with CRA
Corporations must file T5 information by the last day of the February following the calendar year to which it belongs. Not filing T5 information return on time results in the penalties with a minimum of $100 and a maximum of $7500.
While issuing dividend you need to understand the following terms (for Canada only).
Type of Dividend – Eligible Vs Non-Eligible Dividends
Dividends issued by public corporations are eligible dividends. When a CCPC issues dividend, it can be either eligible or non-eligible dividend.
- When a CCPC pays dividends from its income which is within the limit of the small business deduction, it is called non-eligible dividend. Small business deduction (SBD) is a reduction in the corporate tax rate for the active business income of CCPCs and is limited to $500,000 for 2019. In certain cases, different corporations share SBD, in all cases, dividends out of this income pool are non-eligible dividends.
- When a CCPC pays dividend from income pools other than the above which are taxed at full tax rates, it is called eligible dividend. It includes the active business income above the Small business deduction limit
- Dividends paid out of the portfolio income which is derived from the investments of CCPC in public corporations are eligible dividends and are subject to refundable part IV tax of 38.33%. When CCPC pays these dividends to CCPC’s shareholders, it is eligible for a dividend refund. This way the income is not taxed twice.
- Other investment income, other than the above portfolio income, like interest income when distributed to CCPC’s shareholders is non-eligible dividends.
Dividend Gross up & Dividend Credits
For individuals resident in Canada non-eligible dividends are grossed up to arrive at taxable non-eligible dividends. Since dividends are already taxed at corporation level, a dividend credit is available for the personal taxes.
For 2019 and previous years, gross up factor and dividend credits are mentioned as below.
Dividends with NO-TAX
Due to the integration of Canadian tax system, you do not have to pay any personal tax if your investment income doesn’t exceed a certain threshold. Such a threshold, in 2019 for the province of Ontario is $51,800 for eligible dividends and $30,700 for non-eligible dividends. This is applicable only if you have only dividend income and no other source of income.
Income Sprinkling and Tax on Split Income
When corporations dividends re issued to family members of the shareholders to shirt the income from the individual with the higher marginal tax rate to the individual(s) with lower marginal tax rate, Tax on Split Income (TOSI) are also applicable with some exceptions available. Read more about TOSI rules here.
TOSI Rules are very complex and you should always consult a professional corporate accountant or certified individual tax preparation professional.
Above post is written for general information purpose and every individual has a unique financial and tax situation. Readers are advised to contact their accountant to discuss their specific situation. Maroof HS CPA Professional Corporation is an Ontario based professional accounting firm providing business, accounting and tax services in Canada and United States.