More on the Designation of Eligible Dividends

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I thought I would add some clarity to the designation of eligible dividends, as noted in the previous post notice from Canada Revenue Agency .. although you should direct your queries to your own tax preparer or CPA/CA/Accountant for tax professional advice.

Background

Effective January 1, 2007 the small business limit for Canadian Controlled Private Corporations (CCPC) and all groups of associated CCPCs .. will be increased to $400,000. That means that eligible small businesses will be able to earn $400,000 net taxable income and pay income taxes at a lower tax rate. If the business earns more than this figure, any excess is taxed at the normal ‘general corporate income tax rate’, and the portion below the threshold is still taxed at the lower rate.

In Canada, corporations (like individuals) pay both federal and provincial taxes. The rates vary for the provinces. Deloitte Canada has a good summary recap of the corporate tax rates for the years 2005-2011 online that I often look at, if I’m not actually in my own T2 program software itself

Now obviously, it’s quite possible that small business corporations in Canada earn MUCH less money than the $400,000 per year taxable income .. but still end up paying income taxes at the higher corporate rates. One reason might be that there is a group of associated companies .. and sometimes it’s advantageous to allocate the business limit to another company to take advantage of certain R&D or M&P or other tax credits. Another reason might be that the business earns investment income, like dividends and interest and is subject to the higher general corporate tax rates, or fails to pass certain eligibility tests of being a CCPC company.

Eligible and Non-Eligible Dividends

CCPCs are not eligible to designate dividends as “Eligible Dividends” on amounts taxed at the lower rates due to the small business reduction. For CCPCs that pay the higher general corporate tax rates due to investment income .. they are still not eligible to be designated as “Eligible Dividends”. We, as accountants, have to be careful to only consider the amounts in excess of the business limit of $400,000 taxable income at the general corporate tax rates and keep track. For non-CCPC corporations – it’s easier .. although most of clients fall into the former classification.

During the normal course of a year end engagement .. I try to consider many possible options of remuneration that is available generally either to miminize the combined income taxes paid, or best suitable for certain other objectives .. to cover drawings, close to retirement, etc. etc. Ultimately, it will come down to either declaring salaries .. dividends .. both .. or pay the tax inside the corporation. Under the Income Tax Act, for those companies classified as a private corporation and paying higher taxes on certain investment income .. is eligible to receive $1 refund for every $3 of dividends paid to the shareholders. All of this has to be taken into consideration.

When the company pays or declares a dividend to the shareholder(s), I usually write a letter and provide instructions to the company’s lawyer who drafts up a resolution for the minute book, authorized by the shareholders. In addition to informing the lawyer of the details of the dividends paid or declared .. I now must include extra notice to designate to the shareholders that the dividends are either “eligible” or “non-eligible” (in most of my cases being the latter). I believe for 2006, as I prepare the T5’s for my clients .. I am going to have to state on each slip whether they are eligible or non-eligible .. although I could be wrong, as I have not received any new slip/forms yet. Apparently, according to the previous article at the CRA news site .. for 2007 it might be acceptable to just add an inclusion in the minute book that ALL future dividends are either “eligible” or “non-eligible” unless stated otherwise.

Effect of Eligible and Non-Eligible Dividends to the Individual Shareholder

Eligible dividends are grossed up 45% and have a federal dividend tax credit of 19%.

Non-Eligible dividends continue to be grossed up by 25% and have a federal dividend tax credit of 13-1/3%.

Example: Suppose you personally have $40,000 taxable income. The incremental tax on extra income over the $40,000 is approximately .. based on a federal 22% and Manitoba 13.5% rates … or 35.5%. You receive a $10,000 dividend (actual amount) from the corporation.

(A) Eligible dividend
> $10,000 x 1.45 = $14,500 x 35.5% additional taxes = $5,147.50
> $14,500 x 19% federal dividend tax credit = ($2,755.00)
> net additional personal taxes will be: $2,392.50 or approx 24%

(B) Non-Eligible Dividend (aka as before!)
> $10,000 x 1.25 = $12,500 x 35.5% additional taxes = $4,437.50
> $12,500 x 13-1/3% federal dividend tax credit = ($1,666.67)
> net additional personal taxes will be: $2,770.83 or approx 28%

There’s many things to be taken into consideration, including what the corporation has actually paid etc .. and the rates and levels of individuals .. but, you can see some savings in option (A)

Background Links

Background sites:
* My previous post – Designation of Eligible Dividends
* Dept. of Finance – June 29, 2006
* Dept. of Finance – October 16, 2006

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