Tax experts contend that although investors will be paying higher taxes on dividend income starting in 2010, based on changes proposed in the 2008 federal budget, this should be mostly offset by either higher dividend payouts from corporations or higher underlying valuations in those corporations.

“It may be a wash,” says Patricia Lovett-Reid, senior vice president with TD Waterhouse Canada Inc. in Toronto.

That’s because corporations, which will see their corporate tax rates gradually reduced to 15% in 2012 from 22.12% in 2007, as indicated in Ottawa’s 2007 economic statement, will be in a position to pass on tax savings by increasing dividend payments or by plowing savings back into the business, which should boost valuations.

The 2008 federal budget proposed lowering the “gross-up” of dividends from its current level of 45% to 44% in 2010, 41% in 2011 and 38% in 2012. In tandem with the reduced gross-ups, the dividend tax credit will also be lowered from the current 19% to 18% in 2010, 16.5% in 2011 and 15% in 2012.

The dividend tax credit is meant to compensate individual taxpayers for the income taxes that have already been paid by the corporation. With a lowering of corporate taxes, Ottawa’s reasoning goes, a corresponding lowering of the dividend tax credit is fair. The result is a higher tax rate on dividends for individual taxpayers starting in 2010.

For example, an individual taxpayer in the top federal tax bracket who received $100 in dividends will end up paying $14.54 in federal taxes. By 2012, the federal taxes due on that same $100 will be $19.32.

The proposed change has received relatively little attention, overshadowed by other budget initiatives. And the change has faced little opposition, despite the fact that it represents a tax increase. Tax experts aren’t surprised.

“I don’t think there will be large opposition to this,” says Myron Knodel, manager of tax and estate planning with Investors Group Inc. in Winnipeg. “On a theoretical basis, it would be difficult to say this was a bad change.”

One group that will lose out is preferred shareholders. Preferred shares usually have a fixed dividend rate. Such shareholders will end up paying more taxes on the same dividend amount under the proposed changes.

Also, the efficacy of the proposals is contingent on whether the provinces make changes to their corporate taxes and dividend tax credit rates to align themselves with Ottawa’s changes. The fact that the proposed changes won’t come into effect until 2010, however, gives the provinces some room to consider their options.

“They have time to study the rates and the concept of integration [with the federal rates] between now and 2010,” says Jamie Golombek, vice president of tax and estate planning for AIM Funds Management Inc. in Toronto. IE