The Growing Power of Dividends
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The Best Canadian Dividend Stocks to Buy: REITS Canada and other Top Canadian Dividend Stocks.
Topic: Dividend Stocks
June 28, 2024|by Scott Clayton
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How are dividends taxed in Canada?
In short, taxpayers who hold Canadian income-producing stocks as part of their dividend stocks strategy can be eligible for the dividend tax credit in Canada. This means that dividend income will be taxed at a lower dividend tax rate than the same amount of interest income.
Investors in the highest tax bracket pay a dividend tax rate of 39% on dividends, compared to about 53% on interest income. That’s a key reason, why we continue to advise our subscribers to focus on developing a dividend stock strategy. It’s also important to note that investors in the highest tax bracket pay tax on capital gains at a rate of roughly 27%.
But there’s a lot more to it, so let’s dive into the nuances of a dividend stock strategy.
The Growing Power of Dividends
Learn everything you need to know in '7 Winning Strategies for Dividend Investors' for FREE from The Successful Investor.
The Best Canadian Dividend Stocks to Buy: REITS Canada and other Top Canadian Dividend Stocks.
What is the difference between eligible and non-eligible dividends?
Eligible dividends are issued by Canadian corporations that have paid sufficient corporate tax, qualifying for a higher tax credit and lower effective tax rate for shareholders, while non-eligible dividends are issued by companies that paid little or no corporate tax, resulting in a lower tax credit and higher effective tax rate for shareholders.
What is a dividend tax credit?
A dividend tax credit is a tax reduction mechanism that helps compensate shareholders for the corporate taxes already paid on distributed profits, effectively reducing double taxation on dividend income.
As mentioned, Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective dividend tax rate.
This means that dividend income will be taxed at a lower dividend tax rate than the same amount of interest income.
How do I calculate the dividend tax credit?
The dividend tax credit is calculated by applying the appropriate federal and provincial credit rates to the grossed-up amount of eligible or non-eligible dividends received.
If you earn $1,000 in dividend income and are in the top tax bracket, you will pay about $390 in taxes based on the dividend tax rate.
That’s a bit more than capital gains, which offer tax-advantaged income as well. On that same $1,000 in income, you will only pay $270 in capital gains taxes.
But it’s a lot better than the roughly $530 in income taxes you’ll pay on the same $1,000 amount of interest income.
As part of your dividend stock strategy, it’s helpful to know that the Canadian dividend tax credit is actually split between two tax credits. One is a provincial dividend tax credit and the other is a federal dividend tax credit. The provincial tax credit varies depending on where you live in Canada.
Note that apart from the Canadian dividend tax credit giving you a major tax-deferral opportunity, dividends can supply a big part of your overall long-term portfolio gains.
When you add in the security of stocks with dividends going back many years or decades—plus the potential for tax-advantaged capital gains on top of dividend income—Canadian dividend stocks are an attractive way to increase profit with less risk.
How can I use a dividend stock strategy?
Dividends don’t always get the respect they deserve, especially from beginning investors who often underestimate the value of a dividend stock strategy. That mistake is understandable–a dividend stock’s yearly 2% or 3% or 5% yield may not seem like much to many investors. Still, dividends are far more reliable than capital gains. A stock that pays a dividend of $1 this year will probably do the same next year. It may even rise to $1.05.
Savvy investors are paying more attention to dividend yields (a company’s total annual dividends paid per share divided by the current stock price). The best dividend stocks respond by doing their best to maintain, or even increase, their payouts.
What are the tax implications for seniors receiving dividends?
For seniors receiving dividends, the tax implications include:
- Potential for increased taxable income
- Impact on income-tested benefits like Old Age Security (OAS)
- Eligibility for age-related tax credits
- Possible clawback of OAS if net income exceeds the threshold
The specific impact depends on the individual’s overall financial situation.
How do capital gains compares to the dividend tax credit?
In Canada, capital gains are taxed at a lower rate than interest—and dividends. (Note: that doesn’t reduce the importance of a dividend stock strategy to achieving your investment goals.) You have to pay capital gains tax on profit you make from the sale of an asset. An asset can be a security, such as a stock or a bond, or a fixed asset, such as land, buildings, equipment or other possessions. However, you only pay the tax on a portion of your profit. The “capital gains inclusion rate” determines the size of this portion.
If you buy stock for $1,000 and then sell that stock for $2,000, you have a $1,000 capital gain (not including brokerage commissions). You would pay capital gains tax on 50% of the capital gain amount. This means that if you earn $1,000 in capital gains, and you are in the highest tax bracket of 50%, you will pay about $270 in capital gains tax on the $1,000 in gains.
In contrast, interest income is fully taxable, while dividend income is eligible for a dividend tax credit in Canada. In the top tax bracket, you’d pay roughly $530 in taxes on $1,000 in interest income, and you would pay $390 on $1,000 in dividend income.
In summary, dividend income in Canada is taxed at a lower rate compared to interest income due to the dividend tax credit. The dividend tax rate for investors in the highest tax bracket is approximately 39%, while interest income is taxed at around 53%. Capital gains are also taxed at a lower rate of about 27% for those in the highest bracket. The Canadian dividend tax credit consists of both a provincial and federal component, with the provincial credit varying based on the investor’s location within Canada.
It’s crucial for investors to understand these tax implications when developing their dividend stock strategy. By focusing on Canadian dividend stocks, investors can take advantage of the favorable dividend tax rates while also benefiting from the stability and potential for long-term growth that dividend-paying stocks offer. Additionally, the lower tax rates on dividends and capital gains can help investors maximize their after-tax returns and accelerate their wealth accumulation over time.
Do you think it’s right for dividends and other “unearned income” to be taxed?
Does the dividend tax credit drive you to develop a dividend stock strategy or is it just a bonus?
This post was originally published in 2017 and is regularly updated.
Comments
Steve
I just read the article on taxation of dividends and was disappointed to see you did not talk about the gross up we have to do on dividends. How does the gross up play into the overall tax on dividends?
Log in to ReplyTSI Research
The article gives a general look at dividend taxation: As mentioned, Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.This means that dividend income will be taxed at a lower rate than the same amount of interest income.
But more specifically: To claim the federal dividend tax credit, you must first “gross up” the amount of dividends actually received by 38% to determine the taxable amount of dividends. You then compute a dividend tax credit based on this inflated amount.
So, 138% of eligible dividends are included in taxable income for individuals. The additional 38% is called the “gross-up”, which is meant to represent the corporate income tax that has been paid on the income earned by the corporation. The dividend tax credit is then calculated, with the intention of providing a tax credit for the corporate income tax paid. The result is that the marginal tax rate for eligible dividends is quite a bit lower than the marginal tax rate for employment income, interest and foreign dividends. It is also lower than the marginal tax rate for capital gains, but only to a certain level of taxable income.
Log in to ReplyRonald
This report on how dividends are taxed was generalized and should have mentioned that Canadian dividends are bumped up by 38% federally and then you get a dividend tax credit of 15.0198% which comes right off your taxes along with your personal credits. When doing your taxes there are two parts to it. The Federal part and the Provincial part so after doing your Federal taxes you have to do your Provincial taxes and there is a spot where you get to use your dividend tax credit there also although the Provincial credit is not as much as the Federal. All in all the dividend tax credit greatly reduces your taxes. Over the years the dividend tax credit has been reduced from what it was in the late 1970’s but it is still worthwhile. Ron!
Log in to ReplyTSI Editorial Team
Thanks, Ron. Successful Investors know the value of the Canadian dividend tax credit–you certainly do.
Log in to ReplyBruce
There is no such thing as “capital gain tax”. Just like there is no such thing as interest income tax or dividend income tax. Half of the capital gain becomes taxable capital gain, and is added to income like other types of income, to eventually come up with a taxable income amount, and tax is calculated based on your taxable income. There is no specific tax being applied against capital gain to come up with a capital gain tax.
Log in to ReplyTSI Research
Good point, Bruce. Thank you.
Log in to ReplyBill
For most people who are NOT in the highest tax bracket but rather in one of the middle tax brackets dividends are the best deal —you can find such information on Tax charts –ask a decent financial advisor for a copy !!
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