What is a Dividend Tax Credit?
The dividend tax credit is the amount that a Canadian resident applies against his or her tax liability on the grossed-up portion of dividends which will be received from Canadian corporations. The gross-up and the dividend tax credit are applicable to individuals but not the corporations.
How Does a Dividend Tax Credit Work?
In Canada, dividends are considered taxable income to investors. However, they are rarely taxed at the investor’s regular income tax rate. Instead, the Canadian tax system generally requires residents to “gross up” the dividends they receive from many Canadian corporations. Then, the Canadian federal government and the provincial governments both give investors dividend tax credits equal to a percentage of the grossed-up amount, thereby reducing the amount of tax owed on the dividends.
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For example, let’s assume you live in Manitoba and your income tax bracket is 20%. Let’s further assume that the tax system requires you to gross up the dividends you receive by 25%, but that the federal tax rate is 15% and the provincial tax credit is 4%. If you receive $1,000 worth of dividends checks in a year, then you would report $2,000*1.25 = $2,500 of dividend income. To calculate the taxes payable on those dividends, we would first calculate the income tax owed based on your income tax bracket:
$2,500 x 20% = $500
Then we would apply the dividend tax credits. The federal tax credit would be $2,500 x .15 = $375, and the provincial tax credit would be $2,500 x .04 = $100. Thus, the total tax payable on the dividend income is $500 – $375 – $100 = $25. This is equivalent to a 1% tax on the dividends received.
How Dividend Tax Credit impacts the investors?
When the investor receives a dividend payment, they will also receive a voucher that indicates:
- the dividend paid out, and
- the amount of tax credit related to that dividend.
If a retail investor is resident in the UK and pays tax at the basic rate (i.e. their taxable income falls within the basic tax rate threshold of £31,785 for the 2015–16 tax year), they will have to pay no further tax on this dividend income because the tax liability is 10%, the same amount as the tax credit.
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Non-taxpayers are not eligible to reclaim the 10% tax credit on dividends from shares. If the investor’s income, including dividends, means that they pay tax at a higher rate, they will have to pay more tax on their dividend income. The dividend tax rate on income above the basic tax rate threshold of £31,785 but below the higher rate tax threshold of £150,000 in the 2015–16 tax year is 32.5%. Given that the first 10% of the tax due on this dividend income is already covered by the tax credit, in practice the investor will pay 22.5% tax on the gross amount of dividend income falling into this tax band.
About the Author – Yash Tanwar
Commerce graduate from University of Delhi who is currently pursuing for FRM Part-1 2020. He wants to obtain a stronger track record of result making and gain something new skill sets that are applicable to Finance specifically in risk domain.
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