Updated August 2006

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On June 29, 2006, draft legislation was released containing proposals to reduce the tax rate on certain dividends received after 2005 by individuals and trusts.  

In general, the proposed changes will reduce 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 ranges from 24% to 37%, depending on the province of residence. Assuming the provinces make similar changes to their respective regimes, the proposed changes would reduce the tax rate significantly, to as low as 14.6% on eligible dividends. The reduced tax rate will be achieved through 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, as most of the provinces and territories, with the exceptions of Manitoba, Ontario and Quebec, have yet to announce the specifics of their plans. We will provide updates on future developments.

Eligible dividends
Under the draft legislation, only eligible dividends qualify for the reduced tax rate.  The draft legislation sets out rules for determining whether a corporation’s dividends are eligible. 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 particular time. Dividends not paid from the GRIP would be considered ineligible and taxed at the existing higher rate.  

For public corporations and other non-CCPCs resident in Canada, the new rules generally allow eligible dividends to be paid out of net income, unless the corporation has a balance in its low rate income pool (LRIP) at the end of a taxation year. The LRIP, in short, represents the accumulation of net income that has benefited from the small business tax rate and therefore may not be paid out as eligible dividends. A non-CCPC could have an LRIP at the end of a taxation year if it was formerly a CCPC or has received ineligible dividends paid by another corporation. 

Based on the draft legislation, the responsibility of determining whether a dividend is an eligible dividend rests on the payer corporation. The corporation will be required to designate, in writing, a dividend as an eligible dividend.

The draft legislation also places punitive measures on corporations that designate eligible dividends in excess of their capacity to pay such amounts. A special tax will be levied on a corporation that does so, on the amount of the excess. Consequently, it will be critical for a corporation to track income pools to ensure that the balances are accurate.

Impact of the draft legislation
Overall, the impact of the draft legislation will be significant and far-reaching, affecting both individual taxpayers and corporations.  For example, under the proposed rules, 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 under the draft legislation 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.

Now is the time to start thinking about what impact these changes will have on your personal and corporate tax planning. Your local Deloitte professionals are here to assist you along the way.

Personal top tax rate on ordinary and dividend income — 2006

Province	Ordinary income	Current rate/ ineligible dividend	Proposed rate on eligible dividends1
British Columbia	43.70%	31.58%	24.39%
Alberta	39.00%	24.08%	14.65%
Saskatchewan	44.00%	28.33%	18.30%
Manitoba	46.40%	35.25%	23.83%
Ontario	46.41%	31.34%	25.09%
Quebec	48.22%	36.35%2	29.69%3
New Brunswick	46.84%	37.26%	32.09%
Nova Scotia	48.25%	33.06%	23.41%
Prince Edward Island	47.37%	31.96%	22.13%
Newfoundland and Labrador	48.64%	37.32%	30.77%
Yukon	42.40%	28.64%	20.13%
Northwest Territories	43.05%	29.65%	21.42%
Nunavut	40.50%	28.96%	22.23%

¹The combined tax rate on eligible dividends is based on the proposed federal rate reduction and the current provincial dividend tax credit rates. For Manitoba, Ontario and Quebec, the dividend tax credit rates contained in the respective provincial draft legislation have been used.
²32.81% from January 1, 2006, to March 23, 2006.
³28.61% from January 1, 2006, to March 23, 2006.

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