Very few things are better than tax-free income. If you’re not investing in a TFSA, RRSP, or any other tax-advantaged account, the CRA will tax your investment income and realized capital gains.
But dividends from Canadian corporations sometimes come with lower taxes and tax-free benefits. Here’s how it works:
Dividend Tax Credit
Your dividend income from Canadian public companies is not entirely tax-free. You still have to pay taxes; however, a dividend tax credit from the CRA helps to reduce taxes on your dividend income.
The dividends you receive from taxable Canadian corporations can be eligible dividends or dividends other than eligible dividends.
Canadian corporations designate taxable dividends as eligible dividends to the Canada Revenue Agency. Generally, companies pay higher corporate taxes before paying out the eligible dividends. This enables investors to pay lower taxes by claiming a higher dividend tax credit.
When filing your taxes, you need a T5 form, Statement of Investment Income, that shows information on your dividend income. In this form, the actual amount of eligible dividends you receive is found in Box 24, and the taxable eligible dividends in Box 25. Your dividend tax credit on your eligible dividend is usually 15.0198 percent of your taxable eligible dividend amount. The dividend tax credit amount is shown in Box 26 of the T5 form.
Dividend tax credits for other than eligible dividends are a little bit different. The dividend tax credit you receive on other than eligible dividends is lower at 9.0301 percent of your taxable amount of dividends other than eligible dividends.
In your T5 form, you will find the actual amount of other than eligible dividends you receive in Box 10 and the taxable amount of other than eligible dividends in Box 11. The dividend tax credit amount is shown in Box 12 of the T5 form.
Capital Dividends from Private Corporations
If you invest in a private Canadian corporation, you can receive tax-free capital dividends. First, you need to be a Canadian resident, and the corporation must have elected to pay the entire amount of dividends as capital dividends through Form T2054, Election for a Capital Dividend.
Usually, if you receive a capital dividend from the capital dividend account (CDA) of a private Canadian corporation, the CRA does not require you to report this income or pay taxes on it.
Sometimes, you may need to pay taxes on excess capital dividends you receive. This usually happens if the private corporation you invest in pays capital dividends that are classified as excess capital dividends.
The CRA treats excess capital dividends like ordinary taxable dividends. If you receive excess capital dividends, this can result in additional taxes.
Key Takeaway
You can maximize your investment returns by investing in dividend-paying Canadian corporations. Dividend tax credits and tax-free capital dividends help to reduce taxes on your investment income.
Remember, foreign dividends do not qualify for dividend tax credits, and you only have access to these benefits as long as you remain a Canadian resident.
Disclaimer: This article is for general information purposes only, and is not legal, financial, or tax planning advice. Everyone’s situation is unique, and this article cannot apply to every person. The reader should not take any action, or refrain from taking any action, as a result of this article without first obtaining legal or professional advice.
