The federal government is proposing to change the way that the dividend tax credit is calculated for non-eligible dividends as part of the 2013 budget.

Ottawa is proposing to adjust the gross-up factor applicable to non-eligible dividends to 18% from 25%, and the dividend tax credit from 2/3 of the gross-up amount to 13/18. Expressed as a percentage of the grossed-up amount of a non-eligible dividend, the effective rate of the dividend tax credit in respect of such a dividend will be 11%.

This proposed measure will apply to non-eligible dividends paid after 2013.

The current dividend tax credit and gross-up factor applicable to non-eligible dividends overcompensates individuals for taxes presumed to have been paid at the corporate level on active business income, the government says. As such, an individual who receives dividend income from a corporation is in a better tax position than if the individual had earned the income directly.

All Canadian taxpayers should be paying “their fair share,” said Minister of Finance Jim Flaherty in a press conference on Thursday. He added the government wants to ensure the corporate and personal tax systems are more fully integrated.

Income earned by corporations is subject to corporate income taxes and, on distribution as dividends to individuals, it is subject to personal income taxes. Thus, dividends received by Canadian taxpayers are taxed at both the corporate and the personal levels. The dividend tax credit is intended to compensate an individual for corporate income taxes that are presumed to have been paid.

The dividend tax credit is meant to ensure that income earned by a corporation and paid out to an individual as a dividend will be subject to the same amount of taxes as income earned directly by the individual, in a concept called integration.

To calculate the dividend tax credit, an individual is first required to include the grossed-up amount of taxable dividends in income. The dividend tax credit then compensates the individual for the amount of corporate-level taxes presumed to have been paid on the grossed-up amount.

There is a set of two dividend tax rates and gross-up factors to recognize the two different corporate income tax rates that generally apply to corporations:

  • The enhanced dividend tax credit and gross-up are applicable to dividends distributed to an individual from corporate income taxed at the corporate tax rate, and are known as eligible dividends.
  • The ordinary dividend tax credit and gross-up are applied to dividends distributed to an individual from corporate income not taxed at the corporate tax rate, and are known as non-eligible dividends.