The federal government will cut dividend tax rates to deal with the tax arbitrage issue surrounding income trusts, and resume tax rulings on trust conversions, Finance Minister Ralph Goodale announced.

The tax reduction will take the form of an enhanced dividend “gross-up” and tax credit to make the total tax on dividends received from large Canadian corporations more comparable to the tax paid on distributions of income trusts, and to eliminate the “double taxation” of dividends at the federal level. Goodale tabled a Notice of Ways and Means Motion to implement these measures.

“Reducing the tax individuals pay on dividends will encourage savings and investment and will help establish a better balance between the tax treatment of large corporations and that of income trusts,” said Goodale. “This action will benefit Canadians and result in bottom-line tax savings for them.”

He added that National Revenue Minister John McCallum will resume providing advance tax rulings on flow-through entity structures. These rulings were suspended while the government pondered the trust issue, throwing potential conversions into disarray.

“Given the uncertainty surrounding how long this session of Parliament will last, as well as the need for greater certainty and stability in the income trust market, there is a clear case for immediate action. The overwhelming consensus of submissions received in our consultation process was to reduce personal income tax on dividends,” said Goodale in explaining the move. “Today’s announcement acts on that consensus and ends the consultation process.”

An eligible dividend will be grossed-up by 45%, meaning that the shareholder includes 145% of the dividend amount in income. The dividend tax credit will be 19%, based on the 2010 federal corporate tax rate as proposed in the 2005 federal budget. Eligible dividends generally will include dividends paid after 2005 by public corporations that are resident in Canada and subject to the general corporate income tax rate.