Managing investments and taxation can be complex. Most investors would agree that navigating dividend and investment taxation in Canada requires an understanding of key rates, rules and planning strategies.
The good news is that with some knowledge of how investments are taxed in Canada, you can make informed decisions and legally minimize your tax obligations.
In this post, you'll learn precisely how dividends, interest, capital gains and other common investments are taxed in Canada.
We'll cover key tax rates, primary tax forms, corporate investment taxation, and tax planning opportunities. You'll walk away knowing exactly how to manage investment taxation and take advantage of planning strategies for your situation.
Introduction to Taxation of Investments and Dividends in Canada
This section provides an overview of how investments and dividends are taxed in Canada. It outlines key concepts and tax rates that apply to various types of investment income, as well as legitimate tax planning strategies businesses can utilize. Understanding these basic principles is important for making informed investment decisions and structuring your affairs to minimize taxes.
Overview of Investment and Dividend Taxation
The main types of investment income taxed in Canada include:
- Capital gains - 50% of realized capital gains are included in assessable income and taxed at your marginal rate
- Dividends - Eligible dividends receive preferential tax treatment through the dividend tax credit
- Interest - Fully taxed at your marginal tax rate
- Rental income - Net rental income is fully taxable
Dividends paid by Canadian corporations receive special tax treatment to account for corporate taxes already paid. The dividend tax credit reduces personal taxes owed on dividend income.
Key Tax Rates and Rules
- The capital gains inclusion rate is 50%. Only half of realized capital gains are taxable.
- Federal dividend tax rates range from 10.52% to 31.71% depending on tax bracket and dividend type.
- Provincial tax rates on investments and dividends vary by province, ranging from 11% to 25%.
- Interest income is fully taxable at your federal and provincial marginal tax rates.
- Tax rules like capital gains exemptions, lifetime capital gains deductions, and registered account rules can reduce taxes owed.
Tax Planning Opportunities
Strategies to minimize investment and dividend taxes include:
- Using registered accounts like TFSAs and RRSPs
- Claiming capital gains exemptions
- Realizing capital losses to offset gains
- Holding investments for the long term
- Using tax-efficient structures like holding companies
Careful planning is key to reducing taxes legally and maximizing after-tax returns on your investments.
How are investment dividends taxed in Canada?
Dividends from Canadian corporations are subject to both federal and provincial taxes in Canada. There are two main categories of dividends:
Eligible Dividends
Eligible dividends are paid out of corporate income that has already been subject to corporate tax. These dividends receive preferential tax treatment to account for the fact that tax has already been paid at the corporate level.
Specifically, the taxable portion of eligible dividends is subject to a federal tax rate of 15.0198%. The provinces also levy tax on the eligible dividend taxable amount, with rates varying by province. For example, the eligible dividend tax rate is 11.05% in Ontario.
So the combined federal and provincial tax rate on the taxable portion of eligible dividends can range from around 26% to 31%, depending on the province.
Non-Eligible Dividends
Non-eligible dividends are generally paid out of corporate income that has not already been taxed at the corporate tax rate, such as from small business income taxed at the small business rate.
The taxable portion of non-eligible dividends is subject to a federal tax rate of 9.0301%. Again, the provinces levy an additional tax which varies by province. For example, the non-eligible dividend tax rate is 20.53% in British Columbia.
The combined federal and provincial tax rates on non-eligible dividend income ranges from around 25% to 44% depending on the province.
So in summary, investment dividends paid by Canadian corporations are subject to both federal and provincial taxes at rates that depend on the nature of the dividends (eligible vs non-eligible). Shareholders must pay personal tax on the taxable portion of dividends they receive.
How much tax do you pay on investments in Canada?
In Canada, capital gains from investments are taxed at a preferential rate compared to regular income. Here are the key things to know about investment taxation in Canada:
- Only 50% of capital gains are taxable. So if you made a $100 capital gain, only $50 of that would be added to your taxable income.
- The tax rate applied to capital gains depends on your overall income level and province of residence. Generally, capital gains are taxed at your marginal tax rate, which could range from 20% to over 50% depending on your tax bracket.
- Dividends from Canadian corporations receive special tax treatment through the dividend tax credit mechanism. This results in a lower effective tax rate on dividends compared to interest income.
- Taxable capital gains and dividends get added to your total income for the year when calculating your overall tax bill. The exact amount of tax payable on investment income depends on what marginal tax bracket it pushes you into.
- You need to track adjusted cost base and report capital gains/losses when selling investments. Failing to report investment income can lead to reassessments, taxes owed, penalties, and interest.
So in summary, a preferential tax treatment applies to capital gains and Canadian dividends. But tax rates can still be significant at higher income levels. Maintaining proper investment records is key to accurately calculating tax obligations. Consulting a tax professional can help maximize after-tax investment returns.
How are Canadian dividends taxed for US citizens?
The Canadian government imposes a 15% withholding tax on dividends paid to non-resident investors. This includes US citizens living outside of Canada.
However, this Canadian withholding tax on dividends can be claimed as a foreign tax credit on your US tax return, helping reduce your overall US tax liability.
Specifically:
- The 15% Canadian tax withheld can be claimed as a deduction or credit on IRS Form 1116. This helps avoid double taxation.
- For US citizens, Canadian dividend taxes are waived when holding Canadian stocks inside US retirement accounts like IRAs or 401(k)s. So consider using retirement accounts if concerned about the dividend tax.
In summary, the 15% dividend tax in Canada can be recovered when filing your US taxes. And for Americans, it is not applied at all when holding Canadian dividend stocks inside US retirement accounts.
Are reinvested dividends taxable in Canada?
Reinvested dividends are taxable in Canada even if you do not actually receive the income in cash. When you choose to reinvest dividends to purchase more shares, the amount is still reported on your T5 tax slip and must be included as income on your tax return.
Here are some key points on the taxation of reinvested dividends in Canada:
- When you receive a dividend from a Canadian corporation, you must report it as income on your tax return in the year it was paid, regardless of whether you reinvested it or not.
- Even though you did not receive the dividend in cash because it was used to buy more shares, it is still considered taxable income.
- The amount of the reinvested dividends will be reported on your T5 tax slip, which is issued by your broker or investment company.
- You must fully report the amount shown on your T5 slip as "actual amount of eligible dividends" and/or "actual amount of dividends other than eligible dividends" on your personal tax return.
- Failing to report reinvested dividends can lead to problems with the CRA, including being reassessed for unreported income and having to pay interest and penalties.
So in summary, yes reinvested dividends are fully taxable as investment income in Canada. Make sure to accurately report dividend amounts from your T5 even if you chose to reinvest them to buy more shares. Proper reporting is essential for avoiding problems with the Canada Revenue Agency.
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Taxation of Common Investment Types
Investments in Canada are taxed differently depending on the type of investment. Here is an overview of how some common investments are taxed:
Interest and Money Market Investments
Interest income, such as interest earned from savings accounts, GICs, bonds, and money market funds, is fully taxable at an investor's marginal tax rate.
Dividend Investments
Canadian dividends are taxed more favorably than interest income. Eligible Canadian dividends receive a dividend tax credit to account for corporate taxes already paid.
Non-eligible dividends do not receive the same preferential tax treatment but are still taxed at lower rates than interest income.
Capital Gains and Losses
Only 50% of realized capital gains are included in taxable income, referred to as the inclusion rate. This results in lower effective tax rates on capital gains.
Capital losses can be used to offset capital gains realized in the same or future tax years. This allows investors to reduce taxes owed on investment gains.
Mutual Funds and ETFs
Distributions from mutual funds and ETFs are made up of interest, eligible dividends, non-eligible dividends, capital gains, and return of capital. Each type of distribution is taxed according to the rules above.
For example, any interest distributions would be fully taxed at the investor's marginal rate. Eligible dividend distributions would receive the dividend tax credit. Capital gains distributions would be taxed at 50% inclusion rates.
Understanding how different investments are taxed can help investors maximize after-tax returns. Consulting a tax advisor can also help navigate complex tax rules for certain investments.
Primary Income Tax Forms
T5 Tax Slip
The T5 tax slip is used to report various types of investment income, including dividends, interest, royalty payments, and distributions from mutual funds and income trusts. Financial institutions are required to issue a T5 slip to Canadian residents for investment income earned during the tax year. The T5 details the types and amounts of investment income paid, tax withheld, eligible and ineligible dividend designations, and other relevant information. Investors must include the investment income amounts from their T5 slips when filing their personal income tax returns.
T3 Tax Slip
A T3 tax slip contains information on trust or mutual fund income distributions. Financial institutions issue a T3 slip to report earnings from investments held in trusts, such as real estate investment trusts (REITs), income trusts, royalty trusts, and mutual fund trusts. The T3 slip outlines the allocation of income, taxable capital gains, and return of capital distributed by the trust or mutual fund. Canadian taxpayers who receive fund distribution income must report the amounts from their T3 slip when filing personal or corporate tax returns.
Schedule 3
Schedule 3 is used to report capital gains and losses realized in a tax year. When investments like stocks, bonds, and mutual funds are sold, any resulting capital gain or loss must be tracked on Schedule 3. Net capital losses can be carried back 3 years or forward indefinitely to offset capital gains in other years. Schedule 3 summarizes capital transactions, provides details on each capital gain/loss, calculates the capital gain/loss for the year, and tracks loss carryovers. The total capital gain/loss amount from Schedule 3 must be reported on the T1 return. Schedule 3 provides an organized system for tracking capital gains/losses across multiple years.
Corporate Investment and Dividend Taxation
Taxation of Investment Income
Corporations are taxed at a lower rate on investment income compared to individuals. For example, the corporate tax rate on capital gains and dividends is around 50% of personal tax rates. This makes holding investments inside a corporation advantageous from a tax perspective.
However, there are some exceptions. For example, under the small business deduction rules, the first $500K of active business income in a Canadian-controlled private corporation is taxed at a much lower rate (9-12%) compared to investment income (around 50%). So when possible, it's better to pay out dividends to shareholders instead of retaining income passively inside the corporation.
The main types of investment income, and how they are taxed inside a corporation are:
- Interest income - fully taxable at the corporate tax rate (combined federal/provincial).
- Capital gains - only 50% of the gain is included in corporate income and taxed.
- Dividends from Canadian corporations - taxed at a lower rate through the dividend refund mechanism.
- Foreign investment income - tax rules differ by country, with foreign taxes potentially creditable.
So while corporate tax rates on investments are generally lower than personal rates, retaining income passively isn't always the best strategy, especially when the small business deduction could apply instead. Proper planning is key.
Tax-Deferred Plans
There are certain tax-deferred investment plans that allow corporations to shelter investment income:
- Individual Savings Plans (ISPs) - like an RRSP for corporations, lets you deduct contributions and defer tax on investment earnings.
- Refundable Dividend Tax on Hand (RDTOH) - a pool that tracks personal taxes paid on dividends, which can be refunded when dividends are paid out. This effectively shelters investment income earned in a corporation.
For example, if you earn $100k of investment income inside a corporation, contributing $100k to an ISP would defer any taxes owing. The main benefit over just leaving funds invested inside the corporation is that funds can be withdrawn to pay dividends tax-free by using the RDTOH pool. This allows you to access the funds personally while still sheltering investment earnings.
So ISPs and RDTOH pools, when used together, provide a very effective tax deferral mechanism for corporate investment income. They should be considered whenever substantial investment funds are retained.
Dividend Tax Credit
When dividends are paid from a corporation to individuals, a dividend tax credit mechanism is used to recover some of the corporate taxes paid:
- For "eligible" dividends, roughly 40% of dividend income is tax-free for Ontario investors.
- For "non-eligible" dividends, roughly 20% of dividend income is tax-free.
Eligible dividends usually come from public corporations or larger private corps that pay regular corporate taxes. Non-eligible dividends usually come from small business corporations claiming the small business deduction.
So whenever dividends are paid out, shareholders can recover a portion of the corporate taxes paid through dividend tax credits. Proper planning and tracking of dividend types can help maximize these credits and recover the most corporate taxes.
Tax Planning Strategies
Here are some tips and best practices for legally minimizing taxes on investments and dividends in Canada:
Income Sprinkling
Income sprinkling involves shifting income from a high-income family member to a lower-income family member in a lower tax bracket to reduce the overall tax burden. This can be an effective tax planning strategy. Some ways to implement income sprinkling with investments and dividends include:
- Gifting Assets: You can gift assets to your spouse or adult children over the age of 18. Any income they earn from those assets will be taxed at their lower marginal tax rate. However, be aware of attribution rules that may apply.
- Loaning Money: Consider an interest-bearing loan to family members so they can invest. The investment income would be taxed in their hands, not yours. Charge at least the CRA's prescribed interest rate to avoid income attribution.
- Paying Salaries: Pay salaries to lower-income family members for work performed in your business. Ensure salaries are reasonable and commensurate with services provided.
Tax-Preferred Investments
Some investments receive preferential tax treatment in Canada. Focusing your portfolio on these can reduce your overall tax bill:
- TFSAs: Investment income earned in Tax-Free Savings Accounts is exempt from tax, making them ideal for dividends, interest income, and capital gains. Contribute the maximum each year if possible.
- RRSPs: Investment income grows tax-deferred within Registered Retirement Savings Plans until withdrawal. Contribute up to your deduction limit annually and invest using dividend stocks, bonds, etc.
- RESPs: Like RRSPs, investment income earned within Registered Education Savings Plans is tax-free. Maximize contributions for your children/grandchildren.
Consider consulting a tax professional to ensure you fully leverage available tax minimization strategies.
Conclusion
Summary of Key Points
This article has covered some key aspects of investment and dividend taxation that businesses operating in Canada should be aware of, including:
- Dividend income is taxed at a lower rate compared to other sources of personal income. The exact dividend tax rate depends on the province and the individual's tax bracket.
- There are specific reporting requirements for dividends paid to Canadian residents versus non-residents. T5 slips must be issued for dividends paid.
- Tax planning strategies like holding investments in a corporation versus personally can impact taxes owed. Contributing investments to an RRSP can provide tax savings.
- Understanding deemed disposition rules for investments held at death is important for estate planning and minimizing taxes.
Next Steps for Readers
Businesses and individuals with investments should take the following steps to optimize taxes:
- Consult with a qualified tax advisor or accountant to review your personal/corporate tax situation.
- Evaluate whether changes to how you hold investments could minimize taxes.
- Review estate plans to account for deemed disposition of investments at death.
- Stay updated on changing tax laws and rates each year during tax season.
