The New Dividend Tax Regime and how it will Impact how Business Owners Pay Themselves

Last fall, the former Liberal government announced changes to the rules for the taxation of dividends with the end goal being to equalize the treatment of corporations carrying on business and the use of income trusts. The new government confirmed in May the proposed changes would be implemented and in June draft legislation was released containing proposals to reduce the tax rate on certain dividends received after 2005 by individuals and trusts.

Companies that can take advantage of the new tax treatment are ones which incur profits of over $300,000 (2006) and over $400,000 (2007).

The proposed changes will bring into effect:

• The reduction of the effective personal tax rate on “eligible dividends” (explained below).
• Currently, the combined top marginal rate paid by individuals on taxable dividends received from Canadian corporations is 31.6%, assuming B.C. makes similar changes, the tax rate would decrease to 24.4% on eligible dividends.
• The reduced tax rate will be calculated using an increase to the dividend gross-up and the dividend tax credit on eligible dividends.
• Dividends that are not eligible will continue to be taxed at the current rates.

This summary discusses the most significant changes, though many uncertainties still exist.

Eligible dividends

Under the draft legislation, which sets out rules for determining whether a corporation’s dividends are eligible explains what dividends qualify for the reduced tax rate. The rules differ depending upon the status of the corporation. For example, a Canadian-controlled private corporation (CCPC) may pay eligible dividends to the extent that its taxable income is not subject to the small business tax rate (excluding investment income). Such income would accumulate in the general rate income pool (GRIP), representing the balance that may be paid out as eligible dividends at any given time. Dividends not paid from the GRIP would not qualify for the new treatment and would be taxed at the preexisting higher rate.

Based on the legislation, the responsibility of determining whether a dividend is an eligible dividend rests on the payer corporation.

The draft legislation also places disciplinary measures on corporations that designate eligible dividends in excess of their capacity to pay such amounts. A special tax will be levied on the excess amount a corporation that does. Therefore, it will be important for a corporation to accurately their track income pools to ensure balances in the respective pools.

Impact of the draft legislation

Overall, the impact of the draft legislation will be significant, impacting both individual taxpayers and corporations. For example, moving forward, it may be more beneficial for a CCPC to retain its income and pay out eligible dividends to the owner/manager instead of “bonusing down” to the small business tax rate. Further, in certain situations, a CCPC may be able to elect to forego the small business deduction so that it may pay eligible dividends. The structuring of investment holding companies and portfolio investments may also need to be reviewed in order to achieve tax efficiency.

With these new changes in place, it would be a good time to evaluate how they may benefit you this year and in the years coming. GA

For more information on this topic or other financial advice contact Ayrton Financial Inc. 604.687.6808 or email info@ayrtonfinancial.com.