How are dividends taxed in Canada? Here’s a close look at the dividend tax credit

Discover what you need to know to answer the question, “How are dividends taxed in Canada?”

How are dividends taxed in Canada? Taxpayers who hold Canadian dividend-paying stocks get a tax break. Their dividends can be eligible for the dividend tax credit in Canada. This means that dividend income will be taxed at a lower rate than the same amount of interest income.

Investors in the highest tax bracket pay tax of 29% on dividends, compared to about 50% on interest income. Investors in the highest tax bracket pay tax on capital gains at a rate of roughly 25%.


When to trust your dividends

“One of the best ways to judge whether a company will keep paying its dividend, or even increase it, is the dividend payout ratio. This simply measures what portion of a company’s earnings are allotted to paying dividends. If a company keeps its payout ratio fairly steady, say at 7% of earnings, and its earnings grow…”
Pat McKeough has spent years showing investors how to convert high-quality dividend stocks into accelerated earning power. He shows you how you can make work for you in this free report. Download it now.

 

Read this FREE report >>

 


How are Dividends Taxed in Canada? A look at the dividend tax credit:

As mentioned, Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

This means that dividend income will be taxed at a lower rate than the same amount of interest income.

How are dividends taxed in Canada? An example:

If you earn $1,000 in dividend income and are in the top 50% tax bracket, you will pay about $290 in taxes.

That’s a bit more than capital gains, which offer tax-advantaged income as well. On that same $1,000 in income, you will only pay $250 in capital gains taxes.

But it’s a lot better than the roughly $500 in income taxes you’ll pay on the same $1,000 amount of interest income.

The Canadian dividend tax credit is actually split between two tax credits. One is a provincial dividend tax credit and the other is a federal dividend tax credit. The provincial tax credit varies depending on where you live in Canada.

Note that apart from the Canadian dividend tax credit giving you a major tax-deferral opportunity, dividends can supply a big part of your overall long-term portfolio gains.

When you add in the security of stocks with dividends going back many years or decades—plus the potential for tax-advantaged capital gains on top of dividend income—Canadian dividend stocks are an attractive way to increase profit with less risk.

How are dividends taxed in Canada? Savvy investors respect the advantages of dividends

Dividends don’t always get the respect they deserve, especially from beginning investors. A dividend stock’s yearly 2% or 3% or 5% yield may not seem like much to many investors, yet dividends are far more reliable than capital gains. A stock that pays a dividend of $1 this year will probably do the same next year. It may even rise to $1.05.

Savvy investors are paying more attention to dividend yields (a company’s total annual dividends paid per share divided by the current stock price). The best dividend stocks respond by doing their best to maintain, or even increase, their payouts.

Bonus tip: A look at tax on capital gains and how it compares to the dividend tax credit

In Canada, capital gains are taxed at a lower rate than interest—and dividends. You have to pay capital gains tax on profit you make from the sale of an asset. An asset can be a security, such as a stock or a bond, or a fixed asset, such as land, buildings, equipment or other possessions. However, you only pay the tax on a portion of your profit. The “capital gains inclusion rate” determines the size of this portion.

If you buy stock for $1,000 and then sell that stock for $2,000, you have a $1,000 capital gain (not including brokerage commissions). You would pay capital gains tax on 50% of the capital gain amount. This means that if you earn $1,000 in capital gains, and you are in the highest tax bracket of 50%, you will pay $250 in capital gains tax on the $1,000 in gains.

In contrast, interest income is fully taxable, while dividend income is eligible for a dividend tax credit in Canada. In the 50% tax bracket, you’d pay $500 in taxes on $1,000 in interest income, and you would pay $290 on $1,000 in dividend income.

Do you think it’s right for dividends and other “unearned income” to be taxed?

Does the dividend tax credit play into your investment decisions or is it just a bonus?

This post was originally published in 2017 and is regularly updated.

Comments

Tell Us What YOU Think

You must be logged in to post a comment.

Please be respectful with your comments and help us keep this an area that everyone can enjoy. If you believe a comment is abusive or otherwise violates our Terms of Use, please click here to report it to the administrator.