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.