I received a dividend that wasn’t from a related company, but from a public corporation it invested in. Will my company need to pay tax on it?

Probably. In contrast to distributions between related companies, where private Canadian companies receive “portfolio dividends” (i.e. from unconnected companies) from Canadian companies, they do pay tax on the receipt. However, they do not technically include these amounts in income, but rather pay a special type of tax that is refunded to them when they pay dividends. This is intended to prevent them from using the deduction for dividends received to defer income tax.

I received dividends from a non-Canadian company; will I need to pay tax on this?

This deduction is not generally available where the company receives dividends from foreign companies, although there are narrow exceptions when the company operates in Canada.

Are dividends received that relate to all types of shares eligible for the deduction?

No. While dividends received as a result of ownership of the basic shares typically issued by small businesses allow corporate holders to claim this deduction, there are exceptions that function as anti-avoidance rules.

Tax-Free Inter-Corporate Dividends in Canada | Section 112 Deduction Explained

Tax Free Inter-Corporate Dividends

Dividends are distributions of a company’s assets to one or more classes of shareholders in proportion to the shares they own. While dividends are often paid out of retained earnings, they can also take other forms, including shares, physical assets, or even the forgiveness of debts owed to the company.

Inter-corporate dividends occur when one Canadian company pays dividends to another Canadian company that holds shares in it, commonly seen in holding company structures where the same individual or group controls multiple corporations.

How Inter-Corporate Dividends Work

When individuals receive dividends, the Income Tax Act (ITA) applies the “integration” process, aimed at ensuring the income earned in a corporation and paid out as dividends is ultimately taxed at the individual’s marginal tax rate.

By default, dividends are included in the recipient corporation’s income under section 82 of the ITA. However, when the dividend is paid between two Canadian corporations, the receiving corporation may claim a full deduction under section 112, effectively reducing the taxable income by the amount of the dividend.

Purpose of the Section 112 Deduction

The goal is simple:
Corporate profits should be taxed only once, when earned by the operating company.

After that, dividends can move freely within a corporate group (for example, from an operating company to a holding company) without triggering additional corporate-level tax. Only when the funds are eventually paid to a shareholder who is an individual will dividend taxation be integrated into personal tax rates.

Why Companies Pay Inter-Corporate Dividends

Corporations can only pay dividends if:

The payment does not jeopardize their ability to meet obligations as they come due; and
After payment, their assets are not less than their liabilities.

Because companies cannot pay dividends when they are insolvent, many proactively distribute retained earnings to a holding company to:

Protect assets from creditors
Move excess cash or investments out of the operating company
Maintain flexibility for tax planning and succession
Defer personal tax until funds are eventually withdrawn

Inter-corporate dividends that qualify for the section 112 deduction are a cornerstone strategy in corporate structuring and asset protection.

Need guidance on whether your inter-corporate dividends qualify for the section 112 deduction?
Kalfa Law Firm’s corporate tax lawyers can help you structure your companies, protect your assets, and minimize unnecessary tax.

Book a consultation with Kalfa Law Firm today to get clear, strategic advice for your corporate structure.

FAQs

Do companies pay tax on dividends received from a public Canadian corporation?

If your company receives dividends from a taxable Canadian corporation, such as a public company, those dividends are usually not taxed. Your corporation can claim a section 112 deduction, which cancels out the income inclusion. However, Part IV tax may apply, but it’s typically refundable when your corporation pays out taxable dividends.

Are dividends from a foreign company taxable to a Canadian corporation?

Yes. Dividends from a non-Canadian corporation are taxable to a Canadian corporation. They do not qualify for the section 112 deduction. Foreign withholding tax may apply, but your corporation may get foreign tax credits to reduce the total tax paid.

Do dividends on all classes of shares qualify for the section 112 deduction?

Most dividends do qualify, as long as they are:

Paid by a taxable Canadian corporation, and
Considered taxable dividends under the Income Tax Act.

This applies to common shares, preferred shares, and most special share classes. Exceptions apply where anti-avoidance rules kick in, such as capital gains stripping or dividend rental arrangements.

What is the purpose of inter-corporate dividends?

Inter-corporate dividends let companies move money between related corporations without triggering extra tax, as long as the conditions of section 112 are met. This helps with asset protection, tax deferral, and corporate restructuring.

Why are inter-corporate dividends tax-free?

They are tax-free because Canadian tax law aims to tax corporate profits once when earned by the operating company. After that, dividends can move freely within a corporate group. Tax only applies when dividends reach an individual shareholder.

Can a company pay inter-corporate dividends at any time?

A company can only pay dividends if it remains solvent after the payment. If paying the dividend would make the company unable to meet its obligations or reduce assets below liabilities, it cannot legally pay dividends. This is why many companies proactively move profits to a holding company through inter-corporate dividends.