Individual Tax Series: Dividend Taxation: Eligible, Non-Eligible, and Foreign – Understanding the Differences and Tax Implications
- Rylan Kaliel
- Apr 14
- 7 min read
Updated: Apr 20
Dividends are a common type of income for Canadian investors, yet they often raise questions about their tax implications. Understanding the distinctions between eligible, non-eligible, and foreign dividends, along with how they're taxed, is crucial for efficient tax planning and investment strategies. This blog provides clarity on each type of dividend, their tax treatments, and practical considerations for investors.
What Are Dividends?
Dividends are distributions of a company's profits to its shareholders. In Canada, dividend income is taxed differently from other types of income, such as employment or interest income, due to special tax treatments involving dividend tax credits.
What are Eligible, Non-Eligible, and Foreign Dividends?
In Canada, dividends are generally included in one of three categories: eligible, non-eligible, and foreign dividends. These are discussed in more detail below, however, for now it is important to understand that each of these dividends will result in a different tax treatment on your tax return.
The reasoning for having different types of dividends is that dividends do not provide a deduction against a Canadian corporation’s taxes. These corporations will be subject to one of two tax rates, which we would refer to has high and low rate of tax.
If a corporation has paid tax at a high rate of tax, then they will be able to pay eligible dividends, which have a lower tax rate. If the corporation only ever paid at the low rate of tax, then they will have to pay non-eligible dividends, which have a higher tax rate then eligible dividends (although, still lower than the normal tax rate you would pay).
Foreign dividends do not benefit from this change in tax rates, however, if any tax was required to be paid to the country where the dividends originated then you would get a reduction to your taxes for the amount of tax paid to this country.
Now that we have explored the basics of these types of dividends, let’s discuss the general mechanic for taxing these dividends before learning more about the specifics of these types of dividends.
How Does Dividend Taxation Work?
Eligible and non-eligible dividend taxation works in a similar manner but with different rates. The mechanism for these dividends is that they undergo a gross-up and tax credit process. If you receive a dividend of $1,000 you would be required to “gross-up” this dividend up. The thought process is that since the corporation would not be able to deduct the amount of dividends paid and had to pay tax then we should increase the amount of the dividend to determine what the dividend would have been before the corporation paid tax.
Let’s assume you receive a dividend, in this case a non-eligible dividend, of $1,000 and it has a non-eligible dividend gross-up of 15%, you would then calculate the income to report on your return as follows:
At this point it would appear that this would not be advantageous from a tax perspective, you only received $1,000 but you are taxed on $1,150. The next mechanic is to provide a tax credit on the dividend. This tax credit is calculated based on the gross-up amount of the dividend, or in this case $150. Federally, you would get a tax credit for non-eligible dividends of 9/13 of the gross-up. Provincially, you would get a similar tax credit, which, for example in Alberta, is 149/890 of the gross-up on non-eligible dividends. This tax credit provides for a reduction to taxes for the corporate taxes already paid.
Let’s see this in action and compare this to a similar amount of income from employment, assuming a tax rate of 48%, for comparison purposes.
As can be seen, we have a reduced tax rate on dividends when compared to employment. This demonstrates the gross-up and tax credit mechanism in action, the result is that we should end up with a reduced tax rate when compared to other incomes that are taxed at the full rate.
Now that we have a good understanding of the general mechanics, let’s discuss the various types of dividends and how they differ from a tax perspective.
Eligible Dividends
Eligible dividends generally originate from large Canadian corporations, which have paid corporate taxes at higher rates. Typically, a public corporation would be paying an eligible dividend. Corporations that are not public may also pay an eligible dividend provided they have paid a high rate of tax and have a balance in their general rate income pool account.
Because of these higher corporate taxes, recipients of an eligible dividends receive favorable personal tax treatment.
Key Points:
Issued primarily by large Canadian corporations and public Canadian corporations.
Required to include a gross-up of 38%.
Receive a larger dividend tax credit of 6/11 Federally and 227/770 for Alberta (Provincial example) of the gross-up.
Result in a lower effective tax rate for individuals.
Based on the above and comparing this to a similar amount of income from employment, assuming a tax rate of 48%, we would see the following results:
As can be seen, we have a significant decrease in the tax rate on eligible dividends when compared to employment income. This difference reflects the higher tax rate that was paid by the corporation.
Non-Eligible Dividends
Non-eligible dividends typically come from Canadian-controlled private corporations (CCPCs), which pay taxes at lower corporate rates. Consequently, non-eligible dividends receive a smaller tax credit and are taxed at a higher rate compared to eligible dividends.
Key Points:
Generally issued by small businesses and CCPCs.
Required to include a gross-up of 15%.
Receive a lower dividend tax credit than eligible dividends of 9/13 Federally and 149/890 for Alberta (Provincial example) of the gross-up.
Result in a higher effective personal tax rate than eligible dividends.
Based on the above and comparing this to a similar amount of income from employment, assuming a tax rate of 48%, we would see the following results:
As can be seen, we have a decrease in the tax rate on non-eligible dividends when compared to employment income, but not nearly as high of a decrease as eligible dividends. This difference reflects the tax rate that was paid by the corporation and the fact that these dividends were received from corporations that paid a lower rate of tax.
Foreign Dividends
Foreign dividends are paid by corporations residing outside Canada. Unlike Canadian dividends, foreign dividends don't benefit from Canada's dividend tax credits and are subject to foreign withholding taxes, typically deducted at source by the paying country's government.
Key Points:
Subject to foreign withholding taxes, usually between 10% to 30%, depending on tax treaties.
Eligible for a foreign tax credit on your Canadian tax return to help offset double taxation.
No gross-up required on these dividends.
Taxed similarly to regular income in Canada (no dividend tax credit).
The key difference between foreign dividends and non-eligible dividends is the lack of the gross-up and tax credit mechanic, as well as the fact that a foreign tax credit can be utilized to reduce your taxes.
Foreign tax credits will be discussed in more detail in a future blog, however, for our purposes here you would think of this as a direct reduction to your taxes payable based on the amount of taxes you paid to a country other than Canada (with some exceptions).
Based on the above and comparing this to a similar amount of income from employment, assuming a tax rate of 48% and assuming we get a foreign tax credit of 15% of the total, we would see the following results:
As can be seen our effective tax rate is the same between employment and foreign dividends. While the amount we have to pay to the Canadian government is $330, we have to account for the fact that we already paid $150 to a foreign government, which results in our total taxes paid being the same.
Foreign tax credits are typically driven from withholding taxes that are imposed by a foreign government. More details on this in an upcoming blog post.
A Comprehensive Dive into Tax Rates on Dividends
Above we noted that different dividends have different tax rates then employment income, or other income that has a full rate of tax. The example above used 48%, which is the highest tax rate in Alberta, but what tax rate do we expect at all of the other various tax rates? The table below provides an illustration of the expected tax rate on these dividends when compared to the full rate of tax at each of the tax brackets (using Alberta as an example).
* We would normally expect that foreign dividends are taxed at the same rate as the full rate of tax as the only reduction to tax is taxes paid to foreign governments.
As we can see that across all tax brackets eligible and non-eligible dividends are less than the full rate of tax. In fact, in one case eligible dividends actually result in a negative tax rate. This illustrates the value of dividend income and why it is important to ensure these are appropriately recorded on your tax return.
Reporting Dividends on Your Tax Return
Dividends are typically reported to you by financial institutions on tax slips:
T5 slip: Reports eligible and non-eligible dividends from Canadian corporations.
T3 slip: Reports dividends from mutual funds and trusts.
Foreign dividends are reported on T5 or T3 slips or must be calculated from investment statements.
It is recommended that where you have substantial investments a careful reconciliation be performed to ensure that all investment income on your investment statement ties to the T5 or T3 and all of the income is accounted for. Additional pitfalls may arise, such as for foreign income where your investments have a cost greater than $100,000, which would require filing of a T1135 form (more on this later).
Strategic and Tax Planning Considerations
Understanding how dividends are taxed can inform investment decisions, such as:
Allocating dividend-paying investments strategically between registered and non-registered accounts.
Choosing between investing in Canadian companies (favorable dividend tax treatment) and foreign companies (higher potential yields but no dividend tax credit).
Planning how much tax will arise on the dividends and ensuring amounts are appropriately set aside.
Where you can control the payment of dividends, paying out dividends when you are in a favourable tax bracket.
Summary
Grasping the distinctions between eligible, non-eligible, and foreign dividends, and how each is taxed, enables investors to plan strategically and optimize their tax situations. Careful management of dividend income can contribute significantly to achieving long-term investment goals.
Stay tuned for our next blog, where we'll explore foreign income and its tax treatment in Canada.
Need professional accounting guidance? KLV Accounting is here to help. Contact us today to enhance your financial strategy and drive business success!
For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.
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