BACKGROUNDER
Dividend Tax Credit

In today�s Budget, Joan Marie Aylward, Minister of Finance and President of Treasury Board, implemented an adjustment to the Income Tax Act which is designated to achieve integration of the personal and corporate income tax system related to the income of small Canadian Controlled Private Corporations. The technical adjustment will result in a decrease in the dividend tax credit rate from nine per cent to five per cent. The new dividend tax credit rate applies to all dividends declared and paid on or after March 21, 2002. Dividends declared and paid prior to March 21 will be eligible for the nine per cent dividend tax credit.

Integration Principle
One of the principles of the Canadian income tax system is integration between the personal income tax and corporate income tax systems. Owner/managers of small businesses, generally have the option of taking their remuneration either as a salary or a dividend. In theory, income tax integration should result in the same combined corporate income tax/personal income tax liability for small business owners, whether they take income as dividends or salary.

The dividend tax credit mechanism is intended to provide for this integration, resulting in dividend income from small corporations bearing approximately the same amount of tax as if the corporate income had accrued directly to the shareholder in the form of a salary.

A salary is paid by a company from before tax corporate profits, while dividends are paid from after tax profits. For the purposes of calculating federal and provincial personal income tax, the dividend income is multiplied by 125 per cent and this amount, referred to as the "grossed-up dividend," is included in the taxable income of the individual. The taxpayer is provided a dividend tax credit to eliminate any double taxation resulting from taxing the same income in the hands of both the individual and the corporation. The federal dividend tax credit is 13.33 per cent of taxable dividends, while the provincial dividend tax credit was nine per cent.

Provincial Dividend Tax Credit Under Tax on Income
Integration was not possible under the "tax on tax" system because of the variations in provincial personal and corporate income tax rates among provinces. The move to tax on income (TONI) in 2001 enables the province to achieve integration. In fact, as part of the process to implement tax on income, the federal government has encouraged the provinces to integrate the tax on personal and corporate income.

The provincial dividend tax credit is currently set at the pre-TONI effective rate of nine per cent which results in significant over-integration, in that an owner/manager would be better off taking remuneration as dividends, rather than salary. The fully integrated dividend tax credit rate is approximately five per cent.

While the integration principle is aimed at small businesses, the dividend tax credit also impacts shareholders of large, publicly traded, Canadian corporations. When an individual receives dividends from a public company, the same mechanics of gross-up and credit apply to the dividend income. Consequently, individuals receiving dividends from these corporations may also see an increase in tax burden.

Media contact: Tara Laing, Communications, (709) 729-0329.

2002 03 21                             3:00 p.m.