The Canadian Dividend Tax Credit, Explained Simply

Canada’s dividend tax credit is one of the most powerful tax-savings tools for investors. Giving you a generous tax break on dividends, it can boost your after-tax returns. The credit is roughly 15% for all eligible dividends (mainly dividends paid by Canadian stocks). In the paragraphs below, I’ll explain how Canada’s dividend tax credit works, in simple terms. This may be useful to you if you have all your TFSA/RRSP room used up and are considering investing in a taxable account.

The gross up

The first thing you need to know about the dividend tax-credit is that it’s based on “grossed up” dividends, not actual dividends. For eligible Canadian dividends, the gross up is 38%. For other dividends, the gross up is 15%. The dividend tax credit assessed on non-eligible dividends is lower than that for eligible dividends.

Gross payable taxes

Gross tax payable on dividends is assessed on the grossed up amount. So, if you have $10,000 worth of eligible dividend income post-gross up and a 30% marginal tax rate, gross tax payable is $3,000. The credit is assessed on that amount.

The credit

The dividend tax credit on eligible dividends is roughly 15% of the grossed up amount. On non-eligible dividends, it’s roughly 9%. So, to continue with our hypothetical $10,000 dividend windfall example: the dividend tax credit on that is $1,500.

How to calculate the final taxes

Your final taxes owing after the dividend tax credit is gross taxes minus the dividend tax credit. So, to continue our example further, the taxes payable are $1,500.

Example of how it works in practice

Now, to illustrate how the dividend tax credit works with a real world stock:

Let’s imagine you hold $147,840 worth of Fortis Inc (TSX: FTS) stock. Fortis is a Canadian utility stock that many dividend investors like, which makes it a good example to work with. I chose the $147,840 figure because it produces the nice round number of $5,000 in annual dividends, as the table below shows. This amount of dividends can be used to easily illustrate how the dividend tax credit works.

Based on the amounts in the table above and a 30% assumed tax rate, we can calculate the Fortis dividend tax credit, taxes owing and tax savings as follows:

1. $5,000 after the gross up is $6,900.
2. 30% of $6,900 is $2,070. That’s gross taxes owing.
3. 15% of $6,900 is $1,035. That’s the dividend tax credit.
4. $2,070 – $1,035 is $1,035. That’s final taxes owing.
5. Taxes saved is 30% of the pre-gross up amount (30% of $5,000 is $1,500) minus final taxes owing. That works out to $465. “Saved” here refers to the amount saved compared to $5,000 worth of bond interest income.

As you can see, the dividend tax credit saves a Canadian investor with a 30% tax rate several hundred dollars worth of taxes on $5,000 in dividend income. Clearly, the credit pays. So, for investors who have all their TFSA/RRSP room maxed out, or don’t want to be locked up in an RRSP, investing in a taxable account can definitely make sense.