It’s been almost four years since the two-tier tax on dividends was put in place in Canada, so it’s about time The Tax Issue did a little blurb on it, don’t you think? (plus, it’s been a slow week 🙂 )
If you have received a dividend from a Canadian company in recent years, surely you have noticed extra boxes on your T5 slip indicating whether it is “eligible” or “non-eligible” (and I promise never to call you Shirley again 🙂 ).
A non-eligible dividend is taxed at higher rates, because it comes from a private company who’s earnings were taxed at the lower small business rates. Eligible dividends will benefit from a higher dividend tax credit resulting in a lower tax rate to the recipient, as it comes from higher-taxed corporate earnings.
From the recipient’s viewpoint, a dividend is eligible if the paying corporation has provided written notice to that effect. There is no other requirement by the recipient to verify the status of the payment. It is the payer’s responsibility to make the determination.
From the payer’s perspective, there is a separate set of rules to follow, depending on whether the payer is a CCPC or not. Dividends from Canadian public companies will likely be eligible, as they normally pay tax at the high rates. The following commentary, therefore, will focus on Canadian Controlled Private Companies (CCPC’s).
Annual GRIP Calculation
The rules for CCPC’s involve an annual calculation of the “General Rate Income Pool”, or “GRIP”. The GRIP is determined by a formula and, as you may have guessed, consists of essentially the company’s after-tax active business income that did not benefit from the small business deduction. Also added to the GRIP are eligible dividends it has received from other companies. Losses carried back to previous years, will reduce the GRIP. Thus, a GRIP could become negative.
Investment income such as interest, capital gains, rental income and foreign income does not fall into the GRIP. However, dividends from Canadian public companies will likely be eligible, and will therefore increase the GRIP.
A CCPC that pays any dividend can designate it as an eligible dividend. The designation is made by notifying the recipient at the time the dividend is paid. There is no provision for late designations. The CRA will accept a letter to the recipient, or a note on the cheque stub. If all the shareholders are also directors, a notation in the minutes will suffice.
If an eligible dividend exceeds the GRIP as at year end, a special 20% tax is assessed on the excess. Note that you don’t need to have a GRIP at the time of the dividend. The dividend can be paid any time in the year, and is compared to the GRIP balance at year end.
If an excessive eligible dividend is paid, an election is available in lieu of paying the 20% penalty tax. Similar to excessive CDA elections, you can designate the excess to be a separate taxable dividend. This will require the consent of the recipient, who will have to amend the treatment on his tax return.