Tax Question:
What is the most tax-effective method of paying dividends?
Facts:
There are three types of dividends for Canadian Controlled Private Corporations (CCPCs); capital dividends, eligible dividends and non-eligible dividends; and each is taxed differently by CRA. Below we will discuss these further listing the most advantageous first.
Capital Dividends
Capital dividends are tax-free to shareholders. These are paid out of the company’s Capital Dividend Account (CDA) and cannot exceed the balance in the company’s CDA account. The CDA account accumulates through the sum of the non-taxable portion of capital gains and capital dividends received from other corporations over the years among other specific items. This accumulated balance should be paid out before other dividend types use up the tax-free CDA balance.
Eligible Dividends
Eligible dividends are taxed at a lower margin rate of 25.78% (for 2013) in the shareholder’s hands. These are paid out of the corporation’s income which was taxed at the high corporate rate. Eligible dividends cannot exceed the balance in the corporation’s General Rate Income Pool (GRIP) account. The GRIP account accumulates through income the company earns subject to the general corporate tax rate and through eligible dividends received from related companies. After declaring capital dividends, these dividends should be paid second.
Non-Eligible Dividends
Non-Eligible dividends are taxed at the highest marginal rate for all dividends of 33.71% (for 2013) in the shareholder’s hands. These are paid out of the corporation’s taxable income subject to the small business deduction lower corporate tax rate. These dividends should be paid last.
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Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.
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