Dividend Income Taxation

Dividend income is income investors earn from holding stocks that pay dividends. Even if an investor own stocks indirectly, for example, through an equity mutual fund that buys company shares, dividends would be received by the mutual fund and may be paid out.

Dividend income is taxed at a lower rate than interest because of the Dividend Tax Credit (DTC). This tax credit recognizes that a corporation paying a dividend has already paid tax on the earnings within the corporation.

The actual calculation of the Dividend Tax Credit is quite complicated.  Tax payable on dividend income from Canadian corporations is first calculated by “grossing up” the dividends.   A tax credit is then applied which is a percentage of the actual grossed-up amount to the net federal tax payable. Provincial tax is then calculated using the provincial tax rates and a provincial dividend tax credit rate.  In essence, the dividend is being converted to an approximate amount of pre-taxed corporate earnings.

Dividend income is treated more favourable when compared to income received from fixed income type investments including GICs, bonds and other types of similar investments

Investors should not solely make investment decisions based on how income is paid.  Investors should make investment decisions based on their overall investment objectives, time horizon, level of experience and tolerance to risk.  Although tax effectiveness is important, ensuring an investment is suitable is more important. 

Investors seeking tax advice should always seek professional help. 

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