Eligible and non-eligible (or "in-eligible") dividends are the two of the four types of dividends used to move company profits from an Operating Company (OpCo), Holding Company (HoldCo) or other connected subsidiary back into the hands of shareholders. These two types of dividends are determined by the rate which they were already taxed within the corporation (Small business rate or Corporate General Rate) after which "Grossing up" is done on the shareholders final payable dividend to determine how much tax is still liable to pay.
The main reason for this Grossing up is part of the CRA tax integration, so even when a CCPC has paid a lower amount of tax on the first $500,000 of earnings, the Non-eligible dividends will eventually be taxed at a higher rate when paid out as a dividend to a shareholder.
Understanding an Eligible Dividend:
- For a qualifying CCPC, this dividend is on any amount above $500,000
- Taxed at source with a higher rate (between 25% - 30%)
- Grossed up by ~38%
- Tax credit of around ~15% (Federal) and ~10% (Provincial) [25% total credit]
Understanding a non-eligible Dividend:
- For a qualifying CCPC, this dividend is on any amount below $500,000
- Taxed at source with a lower rate (between 11% - 20%)
- Grossed up by ~18%
- Tax credit of around ~11% (Federal) and ~3% (Provincial) [14% total credit]
Example of grossing up of an eligible dividend:
- Bob is a major shareholder in a CCPC called ABC Investments Ltd.
- ABC investments has made a year end profit of $700,000 in which it must pay taxes.
- Because this company is a CCPC, it will pay a lower tax rate on the first $500,000 and a higher tax rate on the remaining $200,000
- Bob decides to pay out a $10,000 Eligible Dividend which was part of the $200,00 tax at a higher marginal rate.
- Come tax time, Bob is sitting in the highest personal tax bracket of 45% which will be a factor when bob needs to calculate his ultimate tax payable on eligible dividend income.
- Bob first calculates the Gross up of the dividend. $10,000 + 38% = $13,800.
- Bob then calculates his tax payable based on his personal income tax rate $13,800 X 45% = $6,210
- Bob then calculates his tax credit for the eligible dividend. $13,800 X ~25% = $3,450
- Bob then does the final calculation to work out how much tax he needs to pay by deducting the credit from the tax payable. $6,210 - $3,450 = $2,760.
- Bob has to pay $2,760 in tax on his $10,000 dividend (or 27.6% tax).
If we want to take the above example one step further, we can see that adding the amount of tax the company would have already paid (~25% - 30%) to the final tax payable once the dividend is received, the final amount of combined personal and corporate tax will equal close to the tax for all investment income (27.6% + 25% = 52.6%).
Why is the combined tax of personal + company tax higher?
The simple answer is CRA tax integration. It's not perfect, but it is meant to mean that balances the playing field and makes little difference if income was earned personally or through a corporation.
The theory of dividend income says: if you take salary or dividend, that there should be no difference in the amount of tax paid if you incorporate personal and corporate tax.