Tax Treatment of Dividends

The dividends an individual receives from Canadian corporations are “grossed up” by 25%. This amount is then included on their income tax form as taxable income. Both Canadian federal and provincial governments then grant individuals a tax credit, equal to a percentage of the grossed up amount. This helps to reduce the actual tax payable.

Let’s run through an example. Susan Smith has a marginal income tax rate of 25% and is located in Alberta, where the provincial dividend tax credit is 6.4%. The federal dividend tax credit is 13.33%. Her total dividends for the year were $250. On the taxable income portion of her tax return she will include $312.50 (250*1.25). Her approximate taxes owing on this dividend would then be $78.13 (312.50*0.25). She also receives dividend tax credits of $41.67 (312.50*13.33%) and $20 (312.50*0.064). Therefore, in all her taxes payable on her dividend is $16.46 (78.13-41.67-20). This amounts to only 5.27% of her original dividend.

Dividend tax credits are implemented in an attempt to offset double taxing, since dividends are paid to shareholders with a corporation’s after-tax profit and the dividends received by shareholders are also taxed.

There are both federal and provincial tax credits.

Australia:
From Wikipedia.org:

Australia has a Dividend Imputation system which allows franking credits to be attached to dividends. This allows recipients of franked dividends to impute (or credit) the corporate tax paid by the paying company. A recipient of a fully franked dividend on the top marginal tax rate will effectively pay only about 26% tax on the cash amount of the dividend .

UK:
From Wikipedia.org:

In the UK, dividends are taxable at special rates and are paid with a notional tax credit that the recipient can then offset against his/her personal income tax bill. The tax credit represents the tax that the company has already paid on the profits represented by the dividend. Although the system is rather complex because of its special ‘investment income’ rates, the upshot of these and the tax credits is that dividends are not double-taxed.

U.S.:
From Wikipedia.org:

Under the new law dividends are taxed at a 15% rate for most individual taxpayers. Dividends received by low income individuals are taxed at a 5% rate until December 31, 2007 and become fully untaxed in 2008. These provisions are set to expire on January 1, 2009.

Personally, I would like to see dividends not taxed at all for personal investors. Yes, in Canada we receive the dividend tax credit which is a reduced rate than our personal income taxes, but it still is collecting taxes twice from the same funds – pretty sneaky and unfair for the government to do. Let the corporations pay the tax and the investors enjoy all their dividends. This might even reduce the strain on the government retirement plans as people will have more of their dividends available to them to support their retirement. That is just my opinion however…