The dividend series – Dividend, Investment Income and Taxes – Part C

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The Federal Dividend Tax Credit in Canada
If you are a shareholder in a Canadian corporation, you may earn dividend income, which should be reported on your tax return. Typically, you also may be eligible to receive the federal dividend tax credit.

This is a non-refundable credit that reduces the amount of tax you owe.The “ dividend tax credit is given to avoid double taxation.”

Eligible and Ineligible Dividends

Corporations designate dividends as eligible or ineligible. The difference is negligible to you, except for tax purposes. As an investor, you’ll be able to note on your T5 statement of investment income whether your dividend is eligible or ineligible.

If you’re an employee who works for the corporation, you’ll receive a T4PS, which is a statement of employee profit sharing plan allocations and payments.

According to the Canada Revenue Agency, other statements that may include dividend income are:

  • T3, statement of trust income allocations and designations;
  • T5013, statement of partnership income;
  • T5013A, statement of partnership income for tax shelters and renounced resource expenses.

Dividend Income and Gross Up
Your dividend income gets added to your taxable income. In addition to reporting the amount you earned in dividend income, you should account for a gross up. Think of a gross up as an increase to account for applicable taxes.

For example, say your job pays $5,000 per week, but your salary is $5,500 per week because your employer wants $5,000 to be your income after taxes. This means your employer has grossed-up your salary.

The CRA has you add in a gross up to account for any tax the corporation has already paid on your dividend income.

Currently, the gross up rate is 38 percent for eligible dividends. Beginning in the tax year 2016, the gross up rate on ineligible dividends is 17 percent. This rate is slated to drop an additional one percent per year for the next two years.

The decrease is due to “corporate taxes going down,”

Calculating Dividend Income With Gross Up

As an example, if you received $200 worth of eligible dividends and $200 worth of ineligible dividends, you would have to gross up you eligible and ineligible dividends by 38 percent and 25 percent, respectively. So, you would claim $526 as dividend income on your return:

  • ($200 X 138 percent) = $276 ($200 X 125 percent) = $250 $276 + $250 = $526

Calculating the Credit

The CRA allows you to calculate the federal dividend tax credit one of two ways:

  1. As a percentage of the grossed up value of your dividend income (15.0198% of eligible dividends, as of 2015);
  2. As a fraction of the gross up portion of your dividend income (6/11 of eligible dividends; as of 2015).

Continuing the example, a $200 eligible dividend had a grossed up value of $276, so either method of calculation would produce the same results:

  • $276 X 15.0198 percent = $41.45 2) $76 X (6/11) = $41.45

Why You Receive Credit

The purpose of the federal dividend tax credit is to balance things out. You receive your share of the corporation’s earnings as a dividend.

You pay a gross up to turn that income back into pretax income — because the corporation has already paid taxes on it — then, you receive a tax credit to make it fair for everyone.

Both you and the corporation aren’t being double-taxed and the CRA subsidizes you for the tax the corporation already paid on your dividends.

Refundable portion of Part I tax
Lines 440, 445, and 450
The refundable portion of Part I tax is part of the refundable dividend tax on hand (RDTOH). More information about RDTOH is in the section that follows.

The refundable portion of Part I tax allows a CCPC that has paid Part I tax on investment income to recover part of that tax when the corporation pays taxable dividends to its shareholders. The refundable portion of Part I tax only applies to corporations that are CCPCs throughout the tax year.

The refundable portion of Part I tax is based on the aggregate investment income and foreign investment income. You have to determine these amounts by completing Parts 1 and 2 of Schedule 7, Aggregate Investment Income and Active Business Income.

Part 1 – Aggregate investment income calculation

The aggregate investment income is the aggregate world source income calculated as follows:

add

  • the eligible portion of the taxable capital gains for the year that is more than the total of:
    • the eligible portion of allowable capital losses for the year
    • the net capital losses from previous years which are applied in the year
  • total income from property (including income from a specified investment business carried on in Canada other than income from a source outside Canada) from which the following amounts have been deducted:
    • exempt income
    • AgriInvest receipts (include the Quebec amount)
    • taxable dividends deductible after deducting related expenses
    • business income from an interest in a trust that is considered property income under paragraph 108(5)(a)

deduct

  • total losses for the year from property (including losses from a specified investment business carried on in Canada other than losses from a source outside Canada)

On line 440 enter the amount of aggregate investment income that you determined on line 092 of Schedule 7.

You can include taxable capital gains and allowable capital losses in a CCPC’s net investment income only if you can attribute the gain or loss to a period of time when a CCPC, an investment corporation, a mortgage investment corporation, or a mutual fund corporation held the disposed property.

Part 2 – Foreign investment income calculation

The foreign investment income is all income from only sources outside of Canada calculated as follows:

add

  • the eligible portion of the taxable capital gains for the year that is more than the eligible portion of allowable capital losses for the year
  • the total income from property from a source outside Canada from which the following amounts have been deducted:
    • exempt income
    • taxable dividends deductible after deducting related expenses
    • business income from an interest in a trust that is considered property income under paragraph 108(5)(a)

deduct

  • the total losses for the year from property from a source outside Canada

On line 445 enter the amount of foreign investment income that you determined on line 079 of Schedule 7.

Calculate the amount of the refundable portion of Part I tax. Enter the amount from line 450 at amount P in the “Refundable dividend tax on hand” area of your return.

References

Subsections 129(3) and 129(4) IT 73, The Small Business Deduction IT 269, Part IV Tax on Taxable Dividends Received by a Private Corporation or a Subject Corporation

Refundable dividend tax on hand

Lines 460, 465, 480, and 485

The RDTOH account only applies to corporations that were private or subject corporations.

A CCPC generates RDTOH on both the Part I tax it pays on investment income, and on the Part IV tax it pays on dividends it receives. For any other type of private corporation, only the Part IV tax it pays generates RDTOH.

For more information on taxable dividends deductible under section 112 or 113, or subsection 138(6), see line 320.

For information on Part IV tax and instructions to complete Schedule 3, see line 712 – Part IV tax payable.

All or part of the RDTOH at the end of the tax year is available as a refund if the corporation pays taxable dividends to the shareholders during the tax year.

You can view refundable dividend tax on hand balances using the “View return balances” service through:

To calculate the RDTOH at the end of the tax year, add the following amounts:

  • the RDTOH balance at the end of the previous tax year (minus any dividend refund issued to the corporation in the previous year)
  • the refundable portion of Part I tax from line 450
  • Part IV tax calculated on line 360 of Schedule 3
  • any balance of RDTOH transferred from a predecessor corporation on amalgamation, or from a wound-up subsidiary corporation

For the first tax year of a new corporation formed as a result of an amalgamation, enter on line 480 all RDTOH balances being transferred from predecessor corporations. Do not include this amount on line 460.

For a parent corporation that wound up a wholly owned subsidiary, enter on line 480 any RDTOH transferred from the subsidiary corporation. On line 460, enter the RDTOH the parent corporation is carrying forward from its previous tax year.

Note

You cannot transfer any RDTOH to a new or parent corporation if, had the predecessor or subsidiary corporation paid a dividend immediately before the amalgamation or wind-up, subsection 129(1.2) would have applied to that dividend.

On line 485, enter the RDTOH at the end of the tax year. Also, enter it at amount T in the “Dividend refund” area of your return.

References
Subsections 129(3) and 186(5)

Dividend refund

A private or subject corporation may be entitled to a dividend refund for dividends it paid while it was a private or subject corporation, regardless of whether it was a private or subject corporation at the end of the tax year.

Note

To claim a dividend refund or to apply the amount to another debit for any tax year, including the same tax year, you have to file your income tax return within three years of the end of the tax year. If your income tax return is not filed within three years of the end of the tax year, the dividend refund becomes statute barred, and will not be issued.

A dividend refund arises if you pay taxable dividends to shareholders, and if there is an amount of refundable dividend tax on hand (RDTOH) at the end of the tax year. To claim a dividend refund, you have to have made an actual payment to the shareholders, unless the dividend is considered paid (a deemed dividend).

For tax years that begin after 2018, a private corporation’s dividend refund will be calculated by reference to two new accounts, the eligible refundable dividend tax on hand (ERDTOH) and the non-eligible refundable dividend tax on hand (NERDTOH). They will replace the existing RDTOH account for those years.

Eligible dividends will generate dividend refunds from ERDTOH, and non-eligible dividends will generate dividend refunds from NERDTOH first, then possibly from ERDTOH. The calculation will effectively require a private corporation to get a refund from its NERDTOH account before it gets a refund from its ERDTOH account, when it pays a non eligible dividend. A transitional rule will preserve the refundability of a corporation’s pre existing RDTOH.

For more information on eligible dividends, go to Eligible dividends or see Line 710 – Part III.1 tax payable.

You can make this payment either in cash, or with some other tangible assets at fair market value, including the following:

  • stock dividends
  • section 84 deemed dividends
  • amounts paid as interest or dividends on income bonds or debentures that are not deductible when calculating income

If you lose your private status following a change in control, a deemed year-end occurs. This allows you to claim a dividend refund for any dividends paid during the deemed short year.

You have to complete Parts 3 and 4 (if they apply) of Schedule 3 to claim a dividend refund. The dividend refund is equal to whichever of the following amounts is less:

  • for tax years that end after 2015, 38 1/3% of taxable dividends that you paid in the year as a private or subject corporation (the previous rate was 33 1/3%). For tax years that end after 2015 and start before 2016, the additional 5% is prorated according to the number of days in the tax year that are after 2015
  • the RDTOH at the end of the tax year

The total of taxable dividends paid for the purpose of the dividend refund is equal to the amount on line 460 of Schedule 3. Refundable dividend tax on hand refers to the amount on line 485 in the “Refundable dividend tax on hand” area of your return.

Parts 3 and 4 of Schedule 3

The following explains how to complete Parts 3 and 4 of Schedule 3. See Parts 1 and 2 of Schedule 3 for explanations on the first two parts of the schedule.

If you paid taxable dividends during the year, complete Part 3 to identify taxable dividends that qualify for the dividend refund.

If the amount of dividends paid includes dividends that do not qualify for the dividend refund, you have to deduct these dividends before completing the calculation in Part 3. In this case, complete Part 4 of Schedule 3 to identify dividends that do not qualify.

Dividends that do not qualify are:

  • dividends paid out of the capital dividend account
  • capital gains dividends
  • dividends paid for shares that do not qualify as taxable dividends, because the main purpose of acquiring the shares was to receive a dividend refund [subsection 129(1.2)]
  • taxable dividends paid to a controlling corporation that was bankrupt at any time in the year

Complete Part 3 of Schedule 3 to identify a connected corporation that received taxable dividends that qualify for the dividend refund.

If the dividend refund is more than the amount of Part I tax payable for the year, we deduct the excess from any other taxes owed under the Income Tax Act. Any balance left over is available for a refund.

If the total dividends paid during the year is different from the total of taxable dividends paid for the purpose of the dividend refund, complete Part 4 of Schedule 3.

References
Section 129
Subsection 186(5)

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