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How dividends are taxed

A dividend from a Canadian corporation is taxed in two steps. The cash received is increased (grossed up) to approximate the corporation's pre-tax profit, and that larger amount is taxed as income. A dividend tax credit then gives back most of the corporate tax already paid. Which gross-up and credit apply depends on whether the dividend is eligible (from a public corporation or other general-rate income) or non-eligible (mostly from small-business income).

The rules

Eligible Non-eligible
Gross-up on the cash dividend 38% 15%
Federal credit, on the grossed-up amount 15.0198% 9.0301%
Ontario credit, on the grossed-up amount 10% 2.9863%

The Ontario credit on non-eligible dividends falls to 1.9863% from 2027.

  • Only the grossed-up amount is added to taxable income, so it also counts toward income tests such as the OAS recovery tax.
  • Dividends from a foreign corporation get neither a gross-up nor a credit. They are taxed as ordinary income; see foreign withholding tax.
  • Dividends inside a TFSA are not taxed. Inside an RRSP they are not taxed as dividends: the withdrawal is ordinary income.

The formula

taxable amount = cash dividend × (1 + gross-up)
credit = taxable amount × (federal rate + Ontario rate)
tax = taxable amount × marginal rate − credit

What the engine does

  • Accepts a dividend as eligible or non-eligible on a non-registered account, grosses it up, adds it to taxable income and subtracts both credits on the person's own return. The tax settles with the following April's return.
  • Also accepts a fund or trust distribution split by slip character: eligible, other, interest, capital gains, foreign income and return of capital.
  • Does not gross up dividends for the alternative minimum tax; see alternative minimum tax.

What it deliberately does not

  • The planner's own accounts earn one annual return, treated as growth in price for a non-registered account. It does not split that return into dividends, so a plan built in the planner shows no dividend tax unless a dividend is entered.
  • It does not model the ex-dividend date, or a drop in price when a dividend is paid.
  • It does not model the corporate tax that the credits stand in for.

Connected to

  • Expected returns and fees · The default return is 6.35% a year, nominal and net of fees, for an 80/20 stock and bond portfolio. It is an expected long-run average, not a forecast, and an account's own rate replaces it.
  • Foreign withholding tax · A foreign country can withhold tax from dividends paid to Canadians; for US dividends the treaty rate is 15%. The foreign tax credit recovers it in a non-registered account, but a TFSA gets no recovery and an RRSP is exempt.
  • The alternative minimum tax · A parallel tax calculation that applies a flat rate to a wider measure of income, so someone with a large capital gain cannot owe almost nothing. The higher of the regular and minimum tax is paid, and any extra is carried forward as credit.
  • The OAS recovery tax · Years where net income clears the threshold repay 15% of the excess out of Old Age Security. The projection withholds it from the OAS cash, exactly as the CRA does, and leaves taxable income unchanged.

Sources