One of the most commonly used methods of returning investments
to shareholders is the declaration of dividends. In this article,
we summarize the tax treatment of some different types of dividend
income for Canadian resident investors.
Canadian corporations can declare both eligible or ordinary cash
dividends. The distinction reflects the difference in tax
treatments on the source income of the dividend.
Eligible dividends are taxed at a lower rate to a shareholder in
comparison to an ordinary dividend. An eligible dividend is paid
out of income of a corporation that was taxed at a high corporate
rate. A Canadian-controlled private corporations
(CCPCs) can only pay eligible dividends to the
extent of its general rate income pool which reflects income that
has not benefited from a preferential tax rate. Generally, a CCPC
is a private corporation that is controlled by Canadian residents.
Non-CCPCs may also pay eligible dividends to the extent that they
do not have a low rate income pool. This pool accounts for income
subject to preferential tax rates, such as income that is taxed at
the small business rate. To pay out an eligible dividend, the
corporation must designate the dividend as such in writing before
or at the time the dividends are paid.
Another useful dividend that a private corporation can pay is a
capital dividend. These dividends are tax-free to Canadian resident
investors. The capital dividend must be paid out from the capital
dividend account of the corporation, which tracks the non-taxable
portion of capital gains and gains on the sale of eligible capital
property received by the corporation. To elect dividends from being
paid out from the capital dividend account, the corporation must
complete form T2054 and submit it to the CRA on or before the
capital dividend is paid or becomes payable.
Lastly, capital gains dividends are distributions made by mutual
fund corporations, investment corporations or mortgage investment
corporations. They are treated as capital gains for tax
In the context of M&A, a vendor to a transaction should
consider whether to distribute part of the proceeds from a sale to
its shareholders and what type of dividend would be most beneficial
for the company and its shareholders. Further, in instances where a
corporation is being sold, the status of its tax accounts, such as
its capital dividend account, may be important considerations for
valuing that corporation.
Norton Rose Fulbright Canada LLP
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The content of this article is intended to provide a
general guide to the subject matter. Specialist advice should be
sought about your specific circumstances.
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Under the Income Tax Act, the Employment Insurance Act, and the Excise Tax Act, a director of a corporation is jointly and severally liable for a corporation's failure to deduct and remit source deductions or GST.
While most are well aware that the sale of a business is generally a complex process, even sophisticated business owners are surprised by just how much cost and effort is required to complete the sale.
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