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The Effects of Reducing the Dividend Gross Up Amount (2012)

Over the last few years, the Canadian government has been reducing the dividend gross up amount along with the federal portion of the dividend tax credit. This isn’t simply a tax grab, but it simply compensates for reduced corporate tax rates. Less corporate taxes mean higher taxes for shareholders so that the tax man retains his share. In 2012, the dividend gross up has been reduced to 38% from 41% in 2011, 44% in 2010, and 45% in 2009/2008.

What exactly is the dividend gross up? It’s a multiple used to calculate taxes owed on dividends received by shareholders.  Since dividends are paid to shareholders with after corporate tax dollars, taxes on those dividends are reduced for the shareholder via a dividend tax credit.  To calculate the taxes owed, dividends received by the shareholder are “grossed up” by a multiple, then the dividend tax credit is applied based on the bigger number, thus less overall taxes paid on the dividend.  A numerical example below will help clarify this a bit.

The decrease in the dividend gross up affects Canadian investors in a couple of ways. First, the bad, the lower gross up ultimately reduces the dividend tax credit thus raising the tax on received dividends in non-registered investment accounts. It’s not all bad however, for seniors there is a slight benefit of reducing the dividend gross up. Since the grossed up amount is counted towards their net income calculations for benefits, the lower gross up results in the benefit of collecting more dividends before old age security (OAS) and other benefits are clawed back.

What difference does a few percentage points in the gross up amount make in real world tax dollars?  Lets compare 2011, where the gross up was 41%, with 2012, where the gross up has been reduced to 38%.  Lets make the assumption that the investor lives in Ontario, made $1,000 in dividend income, and a base salary of $55k for both years.

2011 (41% gross up)

  • Gross Up: $1000 * 1.41 = $1,410
  • Calculate Marginal Tax Rate: $55k (assumed salary) + $1,410 (grossed up dividends) = $56,410 (31.15% in ON)
  • Tax Owing: $1,410 * 31.15%= $439.22
  • Dividend Tax Credit (Federal 16.44%): = $231.80
  • Dividend Tax Credit (ON 6.4%) = $90.24
  • Net Tax: $439.22-$231.80-$90.24=$117.17 (11.72% tax on dividends received)

Assuming the same dividend income but with the 38% gross up and reduced federal dividend tax credit in 2012 results in:

  • Gross Up: $1000 * 1.38 = $1,380
  • Calculate Marginal Tax Rate: $55k (assumed salary) + 1380 (grossed up dividends) = $56,380 (31.15% in ON)
  • Tax Owing: $1380 * 31.15%= $429.87
  • Dividend Tax Credit (Federal 15.02%): = $207.28
  • Dividend Tax Credit (ON 6.4%) = $88.32
  • Net Tax: $429.87-$207.28-$88.32=$134.27 (13.43% tax on dividend received)

As concluded, the tax on dividends received in a non-registered account has increased by almost a couple of percentage points since last year.  Doing the same calculation through all tax brackets brings a similar result.  Comparing this to 2009 when the gross up was 45%, and the federal portion was 18.97% would have resulted in a net tax of 6.93% on the same $1000 in dividends received.  Looks like dividend income is getting more expensive!

But what about OAS and other benefits?  The OAS clawback kicks into gear when income reaches $69,562 per year (2012).  The problem with receiving dividends during senior years is that the grossed up amount counts towards income calculations.   When the gross up was 45% (assuming same maximum income threshold), an investor could receive a maximum of about $47.9k in dividends without reducing OAS payouts (assuming no other income).  However, now that the gross up has been reduced to 38%, the same investor can receive $50.4k in dividends without affecting OAS payouts (assuming no other income).  Not a huge difference, but $2.5k can go a long way in retirement.







23 Comments, Comment or Ping

  1. Although the impact to me hasn’t been that significant, I have started shifting a little bit of my dividends to my TFSA. It really depends on the tax year, but until the governments stabilizes it my guess is that we’ll see it continuing to decrease for the next few years.

  2. It really depends on the direction of corporate taxes. If they keep reducing corp taxes, then dividend investors will continue to see higher taxes.

  3. 3. mode3sour

    Nice. It kind of puts a damper on dividend income. I kind of envy the under 21 crowd who will have lots of TFSA room for their growth dividend payers.

  4. 4. Joe

    Dividends are still vastly more efficient than capital gains and interest. But I agree that this is a terribly ignorant economic policy. Low dividend rates incentivize saving in general and investment in equities in particular. Raising these rates will remove a significant incentive toward the efficient allocation of capital. Lowering corporate tax rates does absolutely nothing. Companies, when faced with a 20% marginal tax on revenue or a 40% marginal tax, cateris paribus, will make the same profit-maximizing decisions. Just a complete ignorance of the race-to-the-bottom embodified by “CUT THE CORPORATE TAX RATE AND BIZ WILL FLOCK HERE” mentality. If they want to grow jobs, they should make direct wage expenses deductible at 120% rather than just 100%. A tax credit to promote hiring? Naw, not in Jim Flaherty’s plan.

    Also, mode3sour, in fairness the current generation of young people suffers from chronic under/unemployment so, even if they are more enlightened than their parents and use the new tax shelter (which is unlikely looking @ RRSP participation), they won’t have money to put into the accounts.

  5. 5. Jerry W

    Great article FT!

    A couple of questions:

    1. In your last paragraph, “However, now that the gross up has been reduced to 38%, the same investor can receive $48.5k in dividends without affecting OAS payouts”, I’m not sure where this $48.5k comes from…

    If I were to use $67,668 divided by 1.38, I would get $49K. Is this how it worked out?

    Also, the number has been raised to $69,562 for 2012, per Service Canada website: http://www.servicecanada.gc.ca/eng/isp/oas/oasrates.shtml

    So, if my calculation was correct, then the investor can receive $50.4k ($69,562 / 1.38) in dividends without affecting OAS payouts in 2012. Right?

    2. Didn’t quire understand “Less corporate taxes mean higher taxes for shareholders so that the tax man retains his share.” in the first paragraph. In this article, less corporate taxes does mean higher taxes for shareholders when they get dividend payouts. But they don’t get charged for higher taxes when they sell their share. So why would the shareholders intend to retain their share? Just don’t quite understand the logic there…

    I’m not being picky, just on my way of learning investing…

    Thanks FT!

  6. @Jerry, excellent comment and observations. You are correct in your assumptions and I should have included the 2012 numbers. I have fixed the article. As well,capital gains tax is a different system than dividends. I’m not really sure where the 50% capital gains inclusion rate comes from – will need to do some digging!

  7. 7. Fit

    T-Class funds. I know everyone hate mutual funds haha just saying. utilize with a corporate class fund. tax deferral while the investment grows. as you turn the tap on later for income, all income is classified as ROC. after that is all used up, only taxed as capital gains. for some, this is a great income tool.

  8. 8. Bojangles

    I don’t think it’s fair to compare $1,000 in dividends in 2011 to $1,000 in dividends in 2012. Since corporate tax rates have decreased from 2011 to 2012, for the same earnings in both years, couldn’t a corporation afford to pay out additional dividends in 2012 since more cash is available after tax? Even if dividends aren’t increased because of this tax reduction, corporations will have more retained earnings.

  9. 9. Steve

    @Joe,

    I’m you managed to get through that post without some Harper bashing. I think your take on the corporate/investor tax trade off is the ignorant one.

    This is a trade off between more money in the hands of the company, or more money in the hands of the shareholders. By moving the taxation further to the shareholder, the company has more money available. They can either increase their dividend, or they can use the money to further invest in the business.

    As a shareholder, you have to ask yourself what is better for your return? Would you rather the company use the tax savings to expand the business and try to get you better returns, or would you rather they increase the dividend and pass the savings back to you? The answer is a personal one but this IS the question to ask yourself.

    Looking beyond selfishness, the government has a responsibility to help all Canadians, so they have to look at it from that perspective too. More money in the hands of the investor doesn’t help anyone but that investor until they start spending their earnings in the economy. Most likely they won’t do that until retirement.

    If that money stays in the hands of the company, they are more likely to spend it immediately on growing the business which expands the economies and creates jobs.

    I may not like my taxes going up, but I’m not just going to blindly blame the government.

  10. @bojangles, it is fair because the govt reduced the div tax credit in 2012 (as shown in the example). Less corp tax means more tax on the shareholder.

  11. 11. SST

    @Steve: the government has a responsibility to help all Canadians…More money in the hands of the investor doesn’t help anyone but that investor until they start spending their earnings in the economy. Most likely they won’t do that until retirement.

    If that money stays in the hands of the company, they are more likely to spend it immediately on growing the business which expands the economies and creates jobs.”

    So now it’s the governments “job” to dictate who spends their PRIVATE capital and when and on what???

    So what if the corp. would increase the dividend, the shareholder will simply pay more taxes — it’s the TAX dollars which the gov’t uses to “help all Canadians”.

    To think additional dividend payments would simply sit dormant (cash in the mattress) until retirement is unfounded. Even if it sits in a basic savings account, the bank will use that deposit in the greater economy (loans etc.), and the interest will be taxed as well. Not to mention that a great deal of shareholders are enrolled in DRIPs, thus giving the gov’t even more tax revenue with which to “help all Canadians”.

    If the gov’t TRULY wanted to “help all Canadians” it would focus a great deal more on effective and efficient spending rather than simple tax hikes. (how’s that for a ‘joke of the day’!)

  12. 12. Bojangles

    My point has nothing to do with the dividend tax credit…a corporation is taxed less so it can afford to increase its dividend or retain more earnings. Yes, less corporate tax means more tax on the shareholder, but it also means more dividends/retained earnings.

  13. 13. Sam

    I understand that the gross up amount on dividends is used to calculate benefits from an OAS, is the same true for other senior benefits like GIS Survivor Benefits?

  14. 14. Steve

    @ SST: You missed FrugalTrader’s point about the government’s revenue being net netural. Here is the situation, the government takes X dollars total from your company, and from your dividend, then changes policy so that it takes less from the company and more from you, but still collects X dollars total.

    To accomplish this, it sets the corporate tax rate and dividend tax rate so that X stays constant. So, if the company uses their tax break to pay you a larger dividend (so the company has the same after tax profit as before) both you, the company and the government end up with exactly the same amount of cash in their pocket before the policy change.

    Companies that do not pay a dividend and reinvest 100% of retained earnings into expanding the company love low corporate rates because it’s like compounding your earnings.

    As an investor, you want the law to be 0% corporate and all tax paid by the investor. This allows the company tax free growth before it pays a dividend. Then when you pay a div, the shareholder has the same after tax if the corp paid tax and div was less.

    However, the government needs stable income, so there is alwasy some corporate tax, but teh lower the better for EVERYONE.

  15. 15. Miki

    Is the same true for other senior benefits like GIS Survivor Benefits?

  16. 16. ETFincomes

    Good article, I didn’t know that Government is quieting reducing the Dividend Gross Up Amount. It is time to put those dividend into the TFSA!

  17. @Miki, yes, I believe that grossed up dividends are counted against GIS. Can anyone confirm that?

  18. Great post.

    Definitely makes sense, to me, to leverage the TFSA for dividend-paying stocks – in part because of the reason you have identified above – taxes on dividends are going to go up I think.

  19. 19. Joe

    Dear Steve,

    Increasing corporate tax on profits incentivizes companies to invest. Whether the company keeps profit as cash or pays dividends, they’ll pay more tax. If they take proper advantage of capital investment credits or expand their payroll, they’ll pay less taxes. Also, my tax credit multiple for labour deductions idea is pretty smart.

    Take an econ course and please don’t embarrass yourself so much.

    Best,

    Joe

  20. 20. Erick

    @FrugalTrader

    I can confirm that the grossed up dividends count against GIS…mainly because I *just* read about it in the latest MoneySense (page 18).

    I can’t find the article on their website, but here’s the breakdown…

    Above the GIS threshold ($16,368 for singles and $21,648 for couples), $1 of:
    - dividends costs you 70 cents of GIS
    - regular income above $3,500 costs you 50 cents of GIS
    - capital gains costs you 25 cents of GIS

  21. 21. Steve

    @Joe,

    You’re absolutely right! Raising corporate taxes is a great idea.

    Stop thinking about this solely from an investor’s perspective and start thinking about it also from the perspective of a business owner and a public servant (government) and what the trade-offs are.

    Save the money on your ‘econ’ course and try speaking with a CMA.

  22. 22. The Reverend

    I tend to agree with Steve. Sorry Joe.

  23. 23. Joe

    Thanks for saying nothing Steve. Again, how does a lower corporate tax rate incentivize investment rather than profit hoarding?

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