TINARFFAA (This is not a request for free acounting services)!
In Canada, the taxable amount of dividends is actually higher than the actual dividends received. IIWIOC (If I’ve worked it out correctly), you are taxed on 125% of the actual dividends you were paid.
Does anybody know the rationale behind this? (And to keep this in GQ, let’s stick to the facts - I already know on the face of it, it’s asinine!)
bump
Something to do with grossing up? Treatment of distributions under corporate tax? More information required? Anyone?
I’m not Canadian and I’m not a Canadian tax expert, but I do have some reference books on tax in various countries.
Is it possible that you are miscalculating by adding the surcharge to the tax rates? Surcharges (such as the Ontario provincial tax rate) are NOT applied as a percent of income, but as a percent of the tax.
Grotesquely Simplified Example: If your income is CAD 125,000 (OK, sure, but it’s the example used in my book), your basic Canadian federal tax is around CA 30,000.
Ontario provincial tax is then calculated as a surcharge, a percent of federal tax, and not as a percent of income – say 42.8% of CAD 30,000 = 12,840. That’s NOT applied to the income of 125k, but to the tax.
Long, long ago (like the 1970s), there used to be a few locations (Sweden comes to mind) where the top marginal rates did exceed 100% at upper income levels. That would mean that if you already earned many hundreds of thousands of kroner, any additional amounts were taxed at more than 100%, and they would pull the tax from the other income. Cute, eh? but Canada ain’t doin’ that.
Ah, hang on, disregard previous post, I leapt to a conclusion (that you were miscalculating the surcharge) before reading the whole chapter.
Dividends from Canadian companies are indeed grossed up by 1/4th for inclusion in taxable income. HOWEVER, there is a tax credit of 16.67% of the pre-grossed up dividend. The net result is a tax savings. Tax credits are (dollar-for-dollar) more valuable than deductions, since the tax credit is applied directly to the tax, not to the income.
Example:
Assumptions: Income of CAD 125,000
Dividend of CAD 1000
Tax on CAD 125,000 = CAD 30,000
Marginal Tax rate = 29% (federal only)
Suppose no gross-up and just added to income:
Dividend = CAD 1000
Income = CAD 125,000
Total = CAD 126,000
Tax = CAD 30,000 + 29% x 1000 = CAD 30,000 + CAD 290 = CAD 30,290
OK, now the actual handling:
Dividend = CAD 1000
Gross Up added to income = CAD 1250
Other income = CAD 125,000
Total Income: CAD 126,250
Tax (from prior example) = CAD 30,000 + 29% x 1250 = 30,362
Tax Credit: 16.67% X 1000 = CAD 167
Total tax: CAD 30,195
So, in this example, the tax on the $1000 dividend is only $195, not $290 as it would be without the complexity.
Even if you’re at the lower marginal rate of 26%, it would work out well, since 1.25% x .26 - .1667 = .1583 is still less than the marginal rate of 26%.
HOpe that helps, and sorry for my earlier assumption.
CKDH: Hey, for a non-Canadian, non-Canadian tax expert, you’ve got a good grasp of the Canadian system! Really appreciate your taking the time to look this up. 
And from what I know from preparing my own returns over the years, what you’re saying is certainly true.
But that’s not the issue at hand. It’s exclusively DIVIDEND income I’m talking about, and I know I didn’t miscalculate, because my figures are based on the information slip provided by the financial institution(T5).
For instance, one slip shows $154.74 (CDN, or $1.98 US ;)) in “actual amount of dividends” (box 10 on the T5), but for purposes of taxable income, I have to report “the taxable amount of dividends” (box 11 on the T5), $193.43. When I referred to doing a calculation in my OP, I meant the calculation to figure out what percentage the taxable amount was compared to the actual amount, as reported on the slip - 125%
It just seems very curious that you’re taxed on MORE than your paid! But there must be some rationale behind it - at least I hope there is.
And likewise, ignore my previous post!
Thanks for working that all out - I didn’t realize that it actually worked out in my favour.
And I think your calcuations help to infer the reasons underlying the gross up: because tax credits are based on the marginal tax rate, it’s one more way of creating a progressive tax system. In theory, there must be a point where the gross-up (which would help put you into a higher tax bracket) cancels out the credit (which is based on the marginal rate).
“In theory”, yes, IF the tax rates were graded small enough. In practice, even at the lowest Canadian rate of 17%, the dividend comes out tax-advantageous over (say) earned interest.
1.25 x .17 - .1667 = .046 is a lower tax rate than the 17%.
I do apologize again for leaping too fast to a conclusion – always risky when dealing with tax stuff. I thought about deleting my goof, but figured that would be using my Powers as Administrator to hide my own stupidity, so I let it stand. Figured it would be fascinatin’ reading for any non-Canadians, anyway. Umhmm. Sure.
Hell, I’m interested. I think you’re onto the rationale D18:
It is a well known feature of classical systems of company taxation that the overtaxation of dividends is more severe for low tax-bracket divend recipients. (BTW we in Australia have a dividend imputation system inspired by the Canadian Carter Commission on company taxes. And no, it doesn’t work.) It looks like your system is designed to ameliorate this effect.