What is the most tax effective method of paying dividends?
There are three types of dividends for Canadian Controlled Private Corporations (CCPCs); capital dividends, eligible dividends and non-eligible dividends; and each are taxed differently by CRA. Below we will discuss these further listing the most advantageous first.
Capital dividends are tax free to shareholders. These are paid out of the company’s Capital Dividend Account (CDA) and cannot exceed the balance in the company’s CDA account. The CDA account accumulates through the sum of the non-taxable portion of capital gains and capital dividends received from other corporations over the years among other specific items. This accumulated balance should be paid out before other dividend types to use up the tax free CDA balance.
Eligible dividends are taxed at a lower margin rate of 25.78% (for 2013) in the shareholders hands. These are paid out of the corporation’s income which was taxed at the high corporate rate. Eligible dividends cannot exceed the balance in the corporation’s General Rate Income Pool (GRIP) account. The GRIP account accumulates through income the company earns subject to the general corporate tax rate and through eligible dividends received from related companies. After declaring capital dividends, these dividends should be paid second.
Non-Eligible dividends are taxed at the highest marginal rate for all dividends of 33.71% (for 2013) in the shareholders hands. These are paid out of the corporation’s taxable income subject to the small business deduction lower corporate tax rate. These dividends should be paid last.
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