Topic: Dividend Stocks

How are Dividends Taxed in Canada? Exploring the Canadian Dividend Tax Credit

February 6, 2024|by Scott Clayton

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As part of your dividend stock strategy, here’s what you need to know to answer the question, “How are dividends taxed in Canada?”

How are dividends taxed in Canada? In short, taxpayers who hold Canadian income-producing stocks as part of their dividend stock strategy 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 39% on dividends, compared to about 53% on interest income. That’s a key reason, why we continue to advise our subscribers to focus on developing a dividend stock strategy. It’s also important to note that investors in the highest tax bracket pay tax on capital gains at a rate of roughly 27%.

But there’s a lot more to it, so let’s dive into the nuances of a dividen stock strategy.

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How are dividends taxed in Canada? A look at the dividend tax credit as a component of your dividend stock strategy :

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—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 tax bracket, you will pay about $390 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 $270 in capital gains taxes.

But it’s a lot better than the roughly $530 in income taxes you’ll pay on the same $1,000 amount of interest income.

As part of your dividend stock strategy, it’s helpful to know that 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 prioritize a dividend stock strategy

Dividends don’t always get the respect they deserve, especially from beginning investors  who often underestimate the value of a dividend stock strategy. That mistake is understandable–a dividend stock’s yearly 2% or 3% or 5% yield may not seem like much to many investors. Still, 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. (Note: that doesn’t reduce the importance of a dividend stock strategy to achieving your investment goals.) 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 about $270 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 top tax bracket, you’d pay roughly $530 in taxes on $1,000 in interest income, and you would pay $390 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 drive you to develop a dividend stock strategy or is it just a bonus?

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