Eligible vs. Non-Eligible Dividends in Canada
When a Canadian private corporation distributes profits to its shareholders, not all dividends are treated the same way under the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (ITA). Dividends paid by Canadian corporations fall into one of two categories, eligible dividends and non-eligible dividends (sometimes called ordinary or ineligible dividends). Each category carries a different gross-up rate, a different dividend tax credit, and a different personal tax outcome for the shareholder who receives it.
Understanding which type of dividend a corporation can pay and what happens if it pays the wrong kind is essential for any business owner taking money out of a Canadian-controlled private corporation (CCPC). This article explains the mechanics of both types of dividends, how the underlying income pools work, and how to plan dividend distributions in a way that is both tax-efficient and compliant.
The Integration Principle
Canada’s dividend tax system is built on the concept of integration. The goal of integration is to ensure that income bears roughly the same total tax burden whether it is earned directly by an individual or first earned by a corporation and then distributed to a shareholder as a dividend. Achieving integration requires a mechanism that accounts for how much corporate tax was already paid before the dividend reached the shareholder’s hands.
The two-tier dividend system is that mechanism. Income taxed at the higher general corporate rate of approximately 26.5% in Ontario in 2025 (15% federal plus 11.5% provincial) leaves less after-tax corporate profit per dollar earned. When that after-tax income is paid out as a dividend, the shareholder receives a more generous dividend tax credit to reflect the higher corporate tax already paid upstream. That is an eligible dividend. Income taxed at the lower small business rate of approximately 12.2% in Ontario in 2025 (9% federal plus 3.2% provincial) leaves more after-tax corporate profit per dollar. When that income is distributed, the shareholder receives a smaller dividend tax credit because less corporate tax has been paid. That is a non-eligible dividend.
In theory, the total tax corporate plus personal on a dollar of business income should be the same regardless of whether it flows through a corporation or is earned directly by an individual. In practice, integration is imperfect, and the outcome depends on the shareholder’s marginal rate, the province, and the corporation’s mix of income types.
What Is an Eligible Dividend?
An eligible dividend is a taxable dividend paid by a Canadian corporation and designated as eligible under ITA s. 89(1). The designation can only be made to the extent the corporation has a positive General Rate Income Pool (GRIP) balance or is a non-CCPC, such as a public corporation, which is always permitted to pay eligible dividends without maintaining a GRIP.
For a CCPC, GRIP tracks the after-tax income that has been taxed at the general corporate rate, income that has not benefited from the small business deduction (SBD) under ITA s. 125. A CCPC’s GRIP balance increases when it earns active business income above the $500,000 SBD limit, earns investment income taxed at the general corporate rate, or receives eligible dividends from other corporations. When a CCPC distributes eligible dividends, its GRIP balance is reduced by the amount designated.
A corporation designates a dividend as eligible by notifying shareholders in writing at or before the time the dividend is paid. The Canada Revenue Agency (CRA) requires that the designation appear on the T5 Statement of Investment Income slip issued to each shareholder, with box 24 reflecting eligible dividend amounts. Without a valid designation made at the time of payment, a dividend is treated as non-eligible.
What Is a Non-Eligible Dividend?
A non-eligible dividend (also called an ordinary dividend) is any taxable dividend that has not been designated as eligible. For a CCPC, non-eligible dividends represent income that benefited from the small business deduction, active business income taxed at the reduced small business rate. This income is tracked through the corporation’s Low Rate Income Pool (LRIP) balance under ITA s. 89(1).
The LRIP concept applies most directly to non-CCPC private corporations. For a CCPC, dividends are non-eligible by default unless the corporation has a positive GRIP balance and makes a valid eligible dividend designation. The practical effect is that a CCPC whose income is primarily sheltered by the small business deduction will, in most years, pay only non-eligible dividends.
Non-eligible dividends are not a structural problem, they are the standard dividend for the vast majority of small business owners in Canada. They carry a smaller dividend tax credit because the underlying income was taxed at a lower corporate rate. The higher personal tax on non-eligible dividends is the system’s way of making up for the lower corporate tax that was paid on the income before distribution so that the total tax across both layers approximates what an individual would have paid directly.
The Gross-Up and Dividend Tax Credit
Dividend taxation in Canada works through a two-step process, a gross-up of the actual dividend received, followed by a dividend tax credit applied against the grossed-up income.
For eligible dividends, the shareholder grosses up the actual dividend by 38%. A shareholder who receives a $10,000 eligible dividend adds $3,800, reports $13,800 of income, and then claims a federal dividend tax credit of 15.0198% of the grossed-up amount (approximately $2,073) under ITA s. 121. Ontario adds a provincial dividend tax credit of 10% of the grossed-up amount ($1,380). These combined federal and provincial credits substantially reduce the personal tax on eligible dividends, reflecting the higher corporate tax that was already paid on the underlying income.
For non-eligible dividends, the shareholder grosses up the actual dividend by 15%. A shareholder who receives a $10,000 non-eligible dividend adds $1,500, reports $11,500 of income, and claims a federal dividend tax credit of 9.0301% of the grossed-up amount (approximately $1,038) under ITA s. 121. Ontario’s provincial dividend tax credit for non-eligible dividends is 3.2863% of the grossed-up amount. The lower credit reflects the lower corporate tax paid on income sheltered by the small business deduction.
At the top marginal rate in Ontario (approximately 53.53% in 2025), a shareholder receiving eligible dividends pays an effective personal tax rate of approximately 39.34%, while a shareholder receiving non-eligible dividends pays approximately 47.74%. When combined with the corporate tax already paid, both types of dividends are designed to approximate the tax a high-income individual would have paid on that income directly, but the split between corporate and personal layers differs materially.
Which Type of Dividend Is Better for Shareholders?
Standing alone, eligible dividends produce lower personal tax for shareholders and are preferable from the shareholder’s perspective at virtually any marginal rate. However, whether a corporation can pay eligible dividends is not simply a matter of preference, it depends on whether the corporation has a positive GRIP balance.
A CCPC that earns most of its income within the SBD limit will typically have no GRIP and can only pay non-eligible dividends. A CCPC that earns income above the SBD limit because it is associated with other corporations sharing the SBD room, because its active business income exceeds $500,000, or because it earns significant investment income taxed at the general rate will accumulate GRIP and can designate a portion of its dividends as eligible.
For business owners operating through a holding company (Holdco) that receives dividends from an operating corporation (Opco), the analysis adds another layer. Eligible dividends received by Holdco from Opco flow into Holdco’s GRIP balance and can be re-designated as eligible when paid out to individual shareholders. Non-eligible dividends received by Holdco flow into Holdco’s LRIP balance and must generally be paid out as non-eligible dividends. The intercorporate dividend deduction under ITA s. 112 eliminates corporate-level tax on dividends passing between connected corporations, but the eligible or non-eligible character of the dividend is preserved through the chain.
What Happens If a Corporation Designates Too Many Eligible Dividends?
A corporation that designates a dividend as eligible in excess of its GRIP balance or that is a CCPC with no GRIP at all has made an excessive eligible dividend designation within the meaning of ITA s. 185.1. The consequence is a special Part III.1 tax equal to 20% of the excessive amount, payable by the corporation. This tax cannot be recouped by simply correcting the designation after the fact.
The corporation can elect under ITA s. 185.1(2) to treat the excessive amount as a non-eligible dividend for the purposes of the shareholder’s personal tax. This election recharacterizes the excess at the personal level, reducing the shareholder’s dividend tax credit to what it would have been on a non-eligible dividend. The election can partially mitigate the tax cost by reducing the shareholder’s overstatement of dividend tax credits, but it does not necessarily eliminate the Part III.1 corporate tax on the excess.
Excessive eligible dividend designations most commonly arise through inadvertence, a CCPC that declares a dividend without first verifying its GRIP balance, or an adviser who misapplies the GRIP calculation. Maintaining an accurate GRIP calculation as part of the annual corporate tax return (Form T2) is the primary safeguard against this exposure.
Salary Versus Dividends
One of the recurring planning questions for CCPC shareholders is whether to take compensation as salary or as dividends. The answer depends significantly on whether the available dividends are eligible or non-eligible, because the personal tax differential between the two types is substantial.
Salary is deductible to the corporation and reduces corporate taxable income, but it generates CPP contributions and does not come with a dividend tax credit. Dividends are paid from after-tax corporate income and are not deductible, but they carry either a generous or modest dividend tax credit depending on type. At the top Ontario marginal rate in 2025, effective personal tax is approximately 53.53% on salary, approximately 47.74% on non-eligible dividends, and approximately 39.34% on eligible dividends. Those headline figures favour dividends, especially eligible dividends, but a full comparison must account for corporate tax already paid, CPP contributions (which salary triggers and dividends do not), RRSP contribution room (generated by salary but not dividends), and the corporation’s specific income pool position.
The passive income grind under ITA s. 125(5.1) adds further complexity. When a CCPC’s associated adjusted aggregate investment income (AAII) exceeds $50,000, the SBD begins to be ground down, meaning more income is taxed at the general corporate rate, which increases the corporation’s GRIP and makes eligible dividend designations available for a larger portion of distributions. This is worth tracking annually rather than assuming the corporation’s income pool position stays constant.
Practical Implications for Business Owners
Dividend planning requires knowing, before any dividend is declared, whether the corporation has a positive GRIP balance and, if so, how large that balance is. A corporation that does not track its GRIP from year to year will not know whether a particular dividend can be designated as eligible, and a mistaken designation creates the Part III.1 tax exposure described above. GRIP is calculated and reported on Schedule 53 of the corporate T2 return, and reviewing that schedule before any significant dividend declaration is a straightforward precaution.
For corporations operating under a shareholders agreement, dividend type is a material consideration that the agreement should address directly. A corporation with shareholders in different marginal rate brackets may have conflicting preferences, a high-income shareholder benefits more from eligible dividends than a shareholder in a lower bracket. A well-drafted shareholders agreement should address dividend policy, including whether dividends will be declared, the minimum amounts, and the preference between eligible and non-eligible distributions so that dividend decisions do not become sources of shareholder conflict.
For business owners contemplating a corporate reorganization adding a holding company to the structure through a Section 85 rollover, for example, the income pool implications should be analyzed as part of the planning, not after the fact. The type of dividends flowing between Opco and Holdco determines what the individual shareholder ultimately receives and at what personal tax rate.
The distinction between eligible and non-eligible dividends is not a technicality, it determines how much personal tax a shareholder pays and whether a corporation faces a 20% penalty tax on a mistaken designation. Getting the dividend type right requires knowing your corporation’s income pool position before any dividend is declared and reviewing that position annually as the corporation’s income composition changes.
At Kalfa Law Firm, we work with business owners to structure their corporations and shareholder arrangements in a way that supports sound dividend planning. We advise on shareholders’ agreements that address compensation and distribution policy, and we coordinate with tax professionals to ensure that dividend declarations are properly supported and documented. If you are taking dividends from a CCPC and have not confirmed your GRIP position, or if a corporate reorganization is changing your income pool structure, contact us at (416) 631-7227 or book a consultation online.
FAQs
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. Updated September 23, 2026
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.
