Most people earn their money through employment income. They work for a private business, corporation, government, or are self-employed. It doesn’t matter who you work for. When you work, you pay the highest amount of tax as a percentage of your income.
I naively thought that everyone paid the same percentage of taxes. I thought income was income. Which is true. But not when it comes to income taxes.
People can make money through employment income, pension Income, government benefits, dividend payments, capital gains and interest payments. The majority of which are taxed at an individual’s marginal tax rate.
If an individual owns Canadian dividend paying ETFs or stocks, then those dividends are taxed at a lower rate. But let’s start at the beginning.
What is a Dividend?
A dividend is a payment made from a corporation’s profits to its shareholders. Dividend payments are usually paid quarterly (every 3 months), semi-annually (every 6 months), or annually( every 12 months).
Dividend payments from Canadian companies are excellent sources of passive income for Canadian residents. There are two types of Canadian dividends; eligible and non-eligible. This post will focus solely on eligible dividends.
What is an eligible dividend?
Eligible Dividends are paid out by corporations after they have already paid taxes. An eligible dividend is is paid out by corporations that have been taxed at the highest corporate rate. So the dividends that an individual receives have already essentially been taxed.
How do you receive dividends?
Dividends are paid out as cash or reinvested back into the fund or stock through a Dividend Re-investment Plan(DRIP).
Whichever option you choose, dividends are taxed at an individual’s marginal tax rate. I know what you’re thinking. Earlier I wrote that dividends aren’t taxed like regular income. Keep reading to find out what happens to your Canadian eligible dividend payments.
You don’t have to worry about your dividends until tax time. But make sure to keep accurate records of your trades and dividend payments. Thankfully, online trading platforms such as Qtrade and Wealthsimple do this for you automatically at the end of the year.
Report Dividends On Your Taxes
When you report your taxes and claim your dividends as income, the CRA adds a dividend gross up. The purpose is to return the dividend to its pre-tax value.
Dividend Gross Up
The Canadian government adds an extra tax to your dividend income. The justification for this is that the corporation that paid you the dividend did so with after-tax dollars. The dividend gross up rate of 38% is added to your dividend payment to equal your taxable income.
The dividend gross up rate is meant to reflect the corporate tax (38%) had the dividend income been paid pre-tax. I think of it as a way for the government to return your dividend income to its pre-tax value.
At this point you might be very confused. I wrote that dividends aren’t taxed like regular income but then stated that they are taxed at a marginal tax rate. Then I said the government adds a 38% tax to the dividend income. I know, it doesn’t sound a like a great way to make money right now. But there is still something special coming.
Dividends are Taxed at Your Marginal Tax Rate
Marginal tax rates vary by province. Go to taxtips.ca and locate your province’s tax rate for your income bracket. This will include the combined federal and provincial income tax. This is also known as the effective tax rate or average tax rate.
Full List of Provincial Income Tax Brackets
Apply the Dividend Tax Credit (Federal and Provincial)
Here it is!
The dividend tax credit gets applied no matter your income level. Find your province of residence and apply the dividend tax credit.
| Province | Eligible Dividend Tax Credit | Federal Dividend Tax Credit | Total |
|---|---|---|---|
| AB | 8.12% | 15.0198% | 23.1398% |
| BC | 12% | 15.0198% | 27.0198% |
| MB | 8% | 15.0198% | 23.0198% |
| NB | 14% | 15.0198% | 29.0198% |
| NL | 6.3% | 15.0198% | 21.3198% |
| NS | 8.85% | 15.0198% | 23.8698% |
| NT | 11.5% | 15.0198% | 26.5198% |
| NU | 5.51% | 15.0198% | 20.5298% |
| ON | 10% | 15.0198% | 25.0198% |
| PE | 10.5% | 15.0198% | 25.5198% |
| QC | 11.70% | 15.0198% | 26.7198% |
| SK | 11% | 15.0198% | 26.0198% |
| YT | 12.02% | 15.0198% | 27.0398% |
Let’s look at a couple examples to see the benefit.
Example # 1
Scenario (Tax Year 2023): An individual with an income up to $49,231 including $10,000 in dividend income. This person lives in Ontario and has a combined tax rate of 20.05%.
An individual with an income up to $49,231 in Ontario would need to pay $2,828 in tax on $10,000 in dividend payments. But wait! We haven’t applied the dividend tax credit yet.
In this example, the dividend tax credit resulted in a negative tax amount. This is great! The negative tax amount is a non-refundable tax credit and it can be used to lower other income taxes.
Example # 2
Scenario (Tax Year 2023): An individual living in Manitoba with $48,000 in employment income and $5000 in dividend income. This income results in a combined federal and provincial tax rate of 27.75%.
An individual who lives in Manitoba with an income between $36,842 and $53,359 would need to pay $1,914.75 in tax on $5,000 in dividend payments. But wait! We haven’t applied the dividend tax credit yet.
In this example, the dividend tax credit resulted in a $320.98 tax bill on $5000 in eligible dividends. Which works out to 6.4% in income tax. Hey, this is much better than the 27.75% tax on regular income for the same income bracket.
Who benefits the most from Canadian Dividends?
Canadian dividend ETFs can be held in any registered or non-registered account. If you hold Canadian Dividend ETFs in a registered account such as an RESP, TFSA, or RRSP, your dividends will not be taxed.
Canadian Dividend ETFs are one of the most tax efficient funds to hold in a non-registered account.
The lower your marginal tax rate, the less tax you pay on your dividends. Essentially, you receive the dividends tax free. Individuals in lower tax brackets pay the least tax on their dividends.
In some provinces such as British Columbia, New Brunswick, Ontario, Northwest Territories, Nunuvut, and Yukon, a dividend tax credit can even trigger a negative tax which can lower other income taxes owed.
Buying Canadian Dividend Paying ETFs or Stocks
Below are a list of some common high dividend Canadian ETFs. Click on the links to find out more details about each fund. These aren’t the only Canadian Dividend ETFs. A quick Google search will show you others.
VDY – Vanguard FTSE Canadian High Dividend Yield Index ETF (MER 0.22%)
VCE – Vanguard FTSE Canada Index ETF (MER 0.06%)
XDV – iShares Canadian Select Dividend Index ETF (MER 0.55%)
XDIV – iShares Core MSCI Canadian Quality Dividend Index ETF (MER 0.11%)
XIU – iShares S&P/TSX 60 Index ETF (MER 0.18%)
XEI – iShares S&P/TSX Composite High Dividend Index ETF (0.22%)
ZDV – BMO Canadian Dividend ETF (MER 0.39%)
Conclusion and Takeaway
Canadian dividend ETFs are a great way to make part of your non-registered investments more tax efficient. Be cautious to not over invest into Canadian Dividend ETFs. The Canadian Stock market accounts for just 2.7% of the global equity market(1). Canadian Dividend ETFs often have only 50 underlying stocks. And these stocks are highly concentrated in banks and energy.
Once you have maxed out your TFSA and RRSP, Canadian Dividend ETFs have a place in every investors’ non-registered investment accounts.