Dividends – How they work

There are two types of dividends that you can receive.  If you invest in publically traded corporations you can receive what are called eligible dividends.  Owners of small business corporations usually receive what are called ineligible dividends (or other than eligible).  Both types of dividends are treated in a similar manner for individual tax purposes, the only difference is the percentages that are applied to gross up the dividend and the percentage that gets applied as a dividend tax credit.  I will be concentrating on ineligible dividends as this is where I get the most questions.

The first thing I want to say is that what I am going to explain is somewhat confusing.  You are going to read this and say WTF?  Followed by “that is stupid”, and then again by “WTF?”.  What is important is that what I am telling you is the way things are done, and that the Department of Finance has its reasons for this convoluted logic and the accompanying calculation.

When you receive and ineligible dividend the amount is grossed up by 18%.  This means that a $100,000 dividend shows up on your tax return as $118,000.  You then get a dividend tax credit to reduce taxes payable equal to $13,000 (118,000 x 0.110162).  This is designed to take into account that the money you are receiving has already had income tax paid on it by the corporation.  Like I said this seems stupid, but it works.