When it comes to dividends, there are two main types: eligible and non-eligible. Eligible dividends are those that meet specific criteria in the Canadian Income Tax Act (ITA). To the contrary, non-eligible dividends do not meet those criteria. This can be confusing for business owners and investors. Let’s take a closer look at what makes a dividend eligible or not.
Eligible dividends are paid by a corporation to its shareholders from its “general rate income pool” (GRIP). To be considered part of the GRIP, earnings must come from business activities in Canada. Usually these dividends are paid by public corporations or private corporations with net income over the $500,000 small business deduction.
For a dividend to be an eligible dividend, the ITA stipulates that the corporation must have paid corporate tax on its profits at the general corporate rate. Therefore, eligible dividends must be paid out of after-tax income from business activities in Canada.
Corporations must make every effort to notify shareholders of an eligible dividend. Because eligible dividends are taxed at a lower rate than non-eligible dividends, this can save shareholders money come tax time.
On the other hand, non-eligible dividends are not subject to the same rules as eligible dividends. These dividends can be paid by any type of corporation, including foreign companies. They are not required to come from the GRIP. Therefore, if a corporation only has passive income, they must pay non-eligible dividends. This is because passive income is not eligible for the small business deduction. Non-eligible dividends are taxed at a higher rate than eligible dividends.
Even though these dividends are taxed at a higher rate, they can still be a good investment for shareholders. Ineligible dividends offer flexibility to corporations in terms of where they can source their profits. For example, they can be a good way to return money to shareholders who are not Canadian residents (since foreign dividends are not subject to the same rules as Canadian ones).
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