What’s the Difference? Eligible v Ineligible Dividends
In Canada, the tax treatment of dividends is a key consideration for both corporations and shareholders. Dividends represent a portion of a company’s profits distributed to its shareholders, and the type of dividend declared can have significant tax implications on its shareholders. Dividends are broadly categorized into two types: eligible dividends and ineligible dividends. Understanding the differences between these two types is crucial for effective tax planning and compliance.
Eligible Dividends
Eligible dividends are dividends paid by a corporation from income that has been subject to the highest rate of corporate tax internally within the corporation. Generally, this includes income from a Canadian-controlled private corporation (CCPC) that has been taxed at the general corporate tax rate (of 26.2% in Ontario), rather than the lower small business tax rate (of 12.2% in Ontario). Because the corporation has paid a higher rate of tax on its internal revenue (26.6%), there is a corresponding benefit to the shareholder when it declares an eligible dividend from the general rate income pool (GRIP), effectively reducing the personal income tax payable on these dividends.
Because they pay less tax on the dividend, shareholders will prefer to receive an eligible dividend.
Ineligible Dividends
Ineligible dividends, on the other hand, are dividends paid from income that has been taxed at the lower small business tax rate of 12.2% (called the Low Rate Income Pool or LRIP) or from income that has not been subject to tax at the general corporate rate. Ineligible dividends are also referred to as “ordinary” dividends. Since the underlying income has been taxed at a lower rate, the dividend tax credit available to shareholders is also lower, meaning shareholders will pay a higher rate of personal income tax on these dividends compared to eligible dividends.
For this reason, the shareholder will prefer to receive an eligible dividend since it will pay a higher rate of tax on receipt of an ineligible dividend.
Compliance and Reporting
Corporate and tax law requires corporations to maintain accurate records of the income from which dividends are paid. This is crucial for determining whether dividends should be classified as eligible or ineligible. Additionally, corporations are required to inform shareholders of the type of dividend they are receiving, which is typically done through a clear designation on dividend statements.In order to declare a dividend, be it eligible or ineligible, a corporation resolution must also be prepared.
Failure to comply with these requirements can result in penalties for the corporation and potentially adverse tax consequences for shareholders. Therefore, both corporations and their shareholders should work closely with tax professionals to ensure dividends are correctly classified and reported.
Conclusion
In Canadian corporate law, the distinction between eligible and ineligible dividends is fundamental to the tax treatment of dividends for both corporations and shareholders. As the landscape of Canadian tax law continues to evolve, staying informed about these distinctions and working with qualified tax and legal professionals can help both corporations and shareholders navigate the complexities of dividend taxation effectively.
Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and private M&A law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law.
© Kalfa Law Firm , 2024
The above provides information of a general nature only. This does not constitute legal or accounting advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.
