The Canadian income tax system is based on a concept of integration. This concept tries to ensure that there is no difference in the total tax bill between income earned directly by an individual or earned first by a corporation and then paid to the same individual as a dividend. There are two corporate tax rates in Canada. The low rate of tax is available to BC Canadian Controlled Private Corporations (CCPC) that generate annual profits under $500,000. In BC these profits are taxed at 13.5%. If a CCPC in BC generates profits over $500,000 they are taxed at around 26.5%.

Although in practice the concept of integration does not work perfectly, for corporations that earn under $500,000 it has been close. Unfortunately, this is not true for corporations that earn over $500,000. To address this imbalance, the idea of eligible dividends was introduced in 2006. The result is that if a dividend is declared as an eligible dividend instead of a regular dividend, the tax treatment in the hands of the individual is lower to offset the higher tax rate in the company.

Eligible dividends cannot be declared indiscriminately, they have to be paid out of a pool of income that was subject to the high rate of tax, otherwise known as General Rate Income Pool (GRIP). The tax savings can be quite extensive. For example, assuming the individual taxpayer pays tax at the high rate, a $50,000 eligible dividend will incur taxes in BC of approximately $10,700, while a regular dividend of the same amount will incur taxes in BC of approximately $16,900. You do want to be careful if eligible dividends are declared in excess of the company’s GRIP balance because the company can be subject to significant penalties.