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In Canada, dividends paid by corporations can be classified as eligible dividends or non eligible dividends. Understanding the distinctions between these two types may help explain differences in tax treatment and how income is reported on a personal tax return. The Canada Revenue Agency (CRA) provides guidance on the reporting and taxation of dividends, including rules on grossed up amounts, dividend tax credits, and corporate designations.

Dividends generally represent a distribution of corporate income to shareholders. However, the type of dividend a corporation pays may depend on its corporate tax rate, business structure, and whether income has benefited from preferential tax treatment such as the small business deduction. As a result, the distinction between eligible vs non eligible dividends has implications for both the corporate level and personal level taxation.

This article explores key differences between eligible and ineligible dividends, how they are grossed up, the associated dividend tax credits, and the tax implications for Canadian resident individuals. It also reviews considerations for Canadian controlled private corporations (CCPCs), public corporations, and owner-managers receiving dividend income.

Definitions: Eligible vs Other-Than-Eligible Dividends

Eligible Dividends

Eligible dividends generally refer to distributions paid by taxable Canadian corporations from income that has been taxed at the general corporate rate. These dividends are conceptually associated with a higher dividend tax credit (DTC) for the recipient, reflecting the greater corporate tax already paid at the corporate level. Eligible dividends may be designated by corporations that maintain sufficient general rate income pool (GRIP), including many public corporations and some Canadian controlled private corporations with income above the small business deduction limit.

Other-Than-Eligible Dividends

Other-than-eligible dividends, sometimes referred to as non eligible dividends, typically originate from corporate income that has benefited from the small business deduction or income taxed at the lower small business rate. Conceptually, these dividends are linked with a lower dividend tax credit, recognizing the lower amount of corporate tax paid.

Actual Dividend vs Taxable Amount

The actual dividend represents the cash or property distributed to the shareholder. For tax purposes, the dividend is often grossed up to reflect pre-corporate tax income, producing the taxable amount that is reported on the shareholder’s personal tax return.

Dividend Tax Credit

The dividend tax credit (DTC) serves as a mechanism to account for tax already paid at the corporate level. The credit reduces the personal taxes payable on the grossed-up dividend, helping mitigate double taxation of corporate earnings.

Quick Glossary

• Taxable Canadian Corporation: a corporation subject to Canadian corporate tax on its income.
• Designated Eligible Dividend: a dividend formally designated by the corporation as eligible.
• Small Business Deduction: a preferential tax treatment for CCPCs on income under the small business limit.
• Marginal Tax Rate: the rate of tax applied to the last dollar of income earned by an individual.

What Are Eligible Dividends?

Eligible dividends generally originate from a corporation that has paid tax at the general corporate tax rate on income not subject to the small business deduction. Canadian public corporations and CCPCs with income above the small business limit may have sufficient general rate income pool (GRIP) to pay eligible dividends.

Key characteristics of eligible dividends:

• They are properly designated by the corporation.
• They typically come from income taxed at a higher corporate tax rate, often from active business income above the small business limit.
• They are subject to a higher gross up when reported on a personal return, which increases the taxable dividend paid for tax purposes.
• Investors receiving eligible dividends may claim a higher dividend tax credit on their personal taxes, which helps offset double taxation of corporate income.

For example, a Canadian controlled private corporation that earns general rate income and maintains sufficient GRIP balance may designate part of its income to be distributed as eligible dividends. This designation allows shareholders to report the grossed up amount and claim the higher dividend tax credit when completing their tax return.

What Are Non-Eligible Dividends?

Non-eligible dividends (sometimes referred to as ineligible dividends) generally arise from small business income that has benefited from the small business deduction. Corporations paying non eligible dividends may include CCPCs earning income under the small business limit.

Key characteristics of non eligible dividends:

• Typically derived from income taxed at the lower small business corporate rate.
• Have a lower gross up on the taxable dividend paid for tax purposes.
• At the personal level, investors claim a lower dividend tax credit, reflecting the lower corporate tax already paid.
• Often appear for owner-managers or shareholders of small businesses distributing earnings below the small business deduction limit.

The distinction between eligible vs non eligible dividends primarily reflects the tax paid at the corporate level. Non eligible dividends attempt to prevent double taxation, but the overall tax burden on investors may differ due to the smaller tax credit.

Gross-Up Mechanism

The gross up increases the taxable amount of a dividend to approximate the pre-corporate tax income from which it was paid.

Eligible dividends typically have a higher gross up, reflecting the higher corporate tax rate on general rate income.

Non eligible dividends have a lower gross up, corresponding to the lower tax paid at the small business rate.

For example:

• An eligible dividend of $100 may have a grossed up amount of $138.
• A non eligible dividend of $100 may have a grossed up amount of $115.

The grossed up amount is reported as taxable dividend income on the shareholder’s personal tax return, which then determines the dividend tax credit.

Dividend Tax Credit

The dividend tax credit (DTC) is designed to reduce double taxation of corporate earnings. It reflects the tax already paid at the corporate level.

• Eligible dividends receive a higher dividend tax credit, reducing the personal taxes owed.
• Non eligible dividends receive a lower dividend tax credit, consistent with the smaller amount of tax paid by the corporation.

The dividend tax credit is claimed on the personal tax return, along with other sources of dividend income, and may include provincial credits depending on the province of residence.

Eligible vs Non-Eligible Dividends: Corporate Considerations

Corporations must track income to determine whether they have sufficient GRIP balance to pay eligible dividends.

Key points:

• Only corporations with income taxed at the general corporate rate can designate eligible dividends.
• Small business income under the small business limit generally results in non eligible dividends.
• The corporate records must properly designate dividend types for shareholders to report correctly.

Owner-managers and shareholders of CCPCs often monitor eligible vs non eligible dividends for tax planning purposes, but the decision to pay dividends depends on the corporation’s GRIP balance and corporate tax position.

Examples of Dividend Types

Public Corporations

• Often pay eligible dividends because their income is taxed at the general corporate rate.
• Shareholders typically report grossed up amounts and claim the higher dividend tax credit.

Canadian Controlled Private Corporations

• May pay non eligible dividends from small business income under the small business deduction limit.
• Eligible dividends may also be paid if the corporation has sufficient GRIP balance from income above the small business limit.

Tax Implications for Shareholders

The taxable dividend reported on a personal tax return depends on the grossed up amount of the dividend. The dividend tax credit offsets part of the taxes paid at the shareholder level.

Key considerations:

• Eligible dividends: higher gross up, higher tax credit, potentially lower overall tax burden.
• Non eligible dividends: lower gross up, lower tax credit, reflecting small business corporate tax paid.
• Both types contribute to investment income and may impact CPP contributions for individuals.
• Dividend income from Canadian corporations is included in taxable income.

Impact on Personal Taxes

The difference between eligible vs non eligible dividends directly affects personal taxes:

• Grossed up amounts are included in taxable income.
• Dividend tax credits reduce taxes payable, with higher credits for eligible dividends.
• Provincial credits may also apply, varying by province.
• Dividend classification may influence overall tax burden for shareholders, especially owner-managers of CCPCs.

Planning and Reporting Considerations

Although shareholders do not control the type of dividend received, understanding eligible vs non eligible dividends may help interpret taxable amounts reported on T5 slips or corporate records.

Considerations may include:

• Reviewing the grossed up amount on slips.
• Confirming whether the corporation properly designated dividends.
• Understanding the dividend tax credit applied in the personal tax return.
• Recognizing the relationship between small business income, GRIP balance, and dividend type.

Summary of Eligible vs Non Eligible Dividends

The distinction between eligible vs non eligible dividends primarily reflects the corporate tax rate paid on the income distributed.

Common Misconceptions About Dividends

Dividend Amount Received Equals Taxable Amount

A common misunderstanding is that the cash or property received from a dividend matches the taxable amount reported on a personal return. In Canada, dividends are often grossed up to reflect pre-corporate-tax income, creating a taxable amount that can differ from the actual payment. This process helps calculate the dividend tax credit and aligns with CRA reporting requirements.

All Canadian Dividends Are Eligible

Not all dividends from Canadian corporations qualify as eligible dividends. Corporations may also pay other-than-eligible dividends, often arising from income taxed at the small business rate. Eligibility depends on factors such as corporate tax rate paid, general rate income pool, and formal designation by the corporation.

Slip Is Not Just an Account Activity Log

T5 or T3 slips report income for tax purposes, rather than serving as a simple record of account transactions. Slips detail taxable dividends, grossed up amounts, and tax credits, enabling accurate reporting on a personal tax return.

Foreign Dividends Are Treated Differently

Dividends from foreign corporations may not qualify for Canadian dividend tax credits. They are typically reported as foreign income and may involve withholding taxes in the foreign country, affecting the taxable amount differently than domestic eligible or other-than-eligible dividends.

Key Takeaways on Dividend Types

In Canada, the distinction between eligible and other-than-eligible dividends reflects differences in corporate tax rates and affects the taxable amount and dividend tax credit reported on a personal tax return. Eligible dividends generally originate from income taxed at the general corporate rate and carry a higher dividend tax credit, while other-than-eligible dividends often come from income taxed at the small business rate and carry a lower credit. Understanding these differences may help clarify reporting on T5 or T3 slips and explain why the grossed up amount can differ from the actual dividend received.