Financial institutions in Canada, particularly the giant lenders, have proven to be stable and profitable amid economic downturns. Many Tax-Free Savings Account (TFSA) users prefer to hold big bank stocks in their accounts to build retirement wealth. They are also dependable sources of income for Canadian retirees.
However, the latest federal budget that raised corporate taxes for banks and insurance companies didn’t sit well with bank executives. The new tax measure calls for a 16.5% tax rate, instead of 15%, on taxable income above $100 million at the financial institutions.
While the threshold is lower than the 18% originally planned by the Liberal government, an analyst for RBC Capital Markets expressed concern. Darko Mihelic said smaller institutions, like Laurentian Bank of Canada and Canadian Western Bank, will also be affected by the surtax.
Fortunately for TFSA investors, big bank stocks like Canadian Imperial Bank of Commerce (TSX: CM)(NYSE: CM) and National Bank of Canada (TSX: NA) remain ideal anchors. Their dividend payments are safe and sustainable, with or without the new surtax.
Wrong signal
CIBC president and CEO Victor Dodig is against a policy that targets specific industries. Instead, he advocates a competitive tax policy and support moves that drive more human capital and foreign direct investment in Canada. He said the tax hike on major financial institutions could send the wrong signal to the world about investing in the country.
Nigel D’Souza, an investment analyst at Veritas Investment Research, said, “It’s not something that’s going to impact the banks’ earnings growth, or the return on equity materially going forward.” However, he warned that the new tax measure sets a precedent for more onerous taxation on bank profits in the future.
Canada’s fifth-largest bank has been paying dividends since 1868. The 154-year dividend track record is a compelling reason to keep CIBC in your TFSA and not sell anytime soon. If you invest today, the share price is $146.74, while the dividend yield is an attractive 4.39%. CIBC’s total return in 49.35 years is 20,126.95% (11.36% CAGR).
Marginal drag
Gabriel Dechaine, an analyst at National Bank of Canada, said before the release of the federal budget that the surtax would only have a marginal drag on the outlook for dividend growth. However, he is worried that such a move would not only backfire on the government but could have unintended consequences.
The bank analyst would have wanted the government to look at other options if it wants highly profitable companies to contribute more to the economy. Dechaine believes an innovation fund would send a less damaging signal to international capital.
Aside from the surtax, banks will have to pay the Canada Recovery Dividend. It’s a one-time 15% on taxable income above $1 billion for the last tax year payable in equal instalments. In fiscal 2021, National Bank’s net income was $3.17 billion — a 53% increase from fiscal 2020. If you invest today ($94.39 per share), the dividend yield is 3.69%.
Dividends are safe
RBC’s Darko Mihelic estimated the average hit of the surtax to affected institutions in fiscal 2023 to be 1.4%. Nonetheless, TFSA investors can take comfort in CIBC and National Bank. Their dividend payments are safe, given the low payout ratios of 41.57% and 31.71%, respectively.
