Dividend Tax Credit
The Dividend Tax Credit (DTC) is a mechanism to reduce the double taxation that occurs when a corporation pays tax on its profits and then distributes those after-tax profits as dividends to shareholders, who would otherwise pay personal tax on the full amount.
The system works through "gross-up and credit": the actual dividend is grossed up (increased by a set percentage to approximate the pre-tax corporate income), then a federal and provincial dividend tax credit is applied to offset the estimated corporate tax already paid. Eligible dividends (from large public corporations paying higher corporate tax) receive a larger gross-up (38%) and credit than non-eligible dividends (from small businesses paying lower corporate tax, grossed up by 15%).
Due to the dividend tax credit, Canadian dividends are taxed at significantly lower effective rates than other income types. At lower income levels, eligible dividends can even result in negative tax (a refund). This makes dividend-paying Canadian stocks tax-efficient in non-registered accounts.
How it works
The dividend tax credit works through a two-step 'gross-up and credit' mechanism rather than a simple percentage reduction. Your actual dividend is first grossed up — increased by a set percentage meant to approximate the pre-tax corporate income that funded it — and the grossed-up amount, not the cash you received, is what you report as income. A federal and provincial dividend tax credit is then subtracted from your tax payable to account for the corporate tax already paid on that income before it reached you.
Eligible dividends, generally paid by large public corporations or by Canadian-controlled private corporations out of income taxed at the general corporate rate, are grossed up by 38% because more corporate tax was already collected on that income. Non-eligible dividends, typically paid out of a small business's income taxed at the lower small-business rate, are grossed up by only 15%, since less corporate tax was paid upstream — the smaller gross-up is paired with a smaller credit.
Because the mechanism exists purely to offset corporate tax already paid, it only applies to dividends from Canadian corporations reported as income on a non-registered account. Dividends from foreign companies don't qualify for the Canadian dividend tax credit — you'd look at the foreign tax credit instead for any foreign withholding tax deducted — and dividends earned inside a TFSA or RRSP don't need it, since that income isn't taxed in the first place.
Example: grossing up an eligible versus a non-eligible dividend
Say you receive a $1,000 eligible dividend from a Canadian public company. You don't report $1,000 as income — you gross it up by 38%, so $1,000 x 1.38 = $1,380 is added to your taxable income.
A non-eligible dividend of the same $1,000 from a small business is grossed up by only 15%, adding $1,000 x 1.15 = $1,150 to your taxable income instead.
In both cases, the dividend tax credit is then applied against your tax payable to offset the extra amount added by the gross-up — a larger credit for the eligible dividend, which was grossed up more, and a smaller one for the non-eligible dividend, which is why eligible dividends usually end up taxed at a lower effective rate than non-eligible ones.
Frequently asked questions
Why do eligible dividends get a bigger dividend tax credit than non-eligible dividends?
Eligible dividends are grossed up by 38% instead of 15% because they generally come from income already taxed at the higher general corporate rate, so a larger credit is needed to offset the larger amount of corporate tax built into the gross-up.
Do dividends from US or other foreign stocks qualify for the Canadian dividend tax credit?
No. The dividend tax credit only applies to dividends from Canadian corporations, since it exists to offset Canadian corporate tax already paid; foreign dividends may instead qualify for the foreign tax credit if foreign withholding tax was deducted.
Does the dividend tax credit apply to dividends earned inside a TFSA or RRSP?
No, and it doesn't need to — dividends earned inside a registered account like a TFSA or RRSP aren't reported as taxable income in the first place, so there's no tax to offset with a credit.
Related Terms
Capital Gains
A capital gain arises when you sell a capital property — such as stocks, mutual funds, ETFs, real estate (other than your principal residence), or cryptocurrency — for more than its adjusted cost base (ACB).
Inclusion Rate
The inclusion rate determines what portion of a capital gain is included in your taxable income.
Marginal Tax Rate
The marginal tax rate is the rate of tax applied to your last (or next) dollar of income.