As readers of this blog know, Joe Monaco and I prepared a presentation last spring on eligible dividends. “Eligible dividends” are taxable dividends paid by a corporation resident in Canada after 2005 that are received by a person resident in Canada and that are designated as eligible for the purposes of the Income Tax Act (Canada). An individual who receives an eligible dividend is entitled to claim an enhanced dividend tax credit. As a result, the effective tax rate on an eligible dividend for an individual otherwise subject to tax at the highest marginal rate is only about 25%.
What are the corporate procedures that a Canadian-controlled private corporation (a CCPC) should follow to pay and designate an eligible dividend?
In answering this question, it is important to remember that a CCPC pays eligible dividends from a special pool called the “general rate income pool” (GRIP). The details of the calculation of GRIP are beyond the scope of this post, but in general terms GRIP represents income earned by a CCPC that has been subject to tax at the full corporate rate. For example, for an investment holding corporation, GRIP would include eligible dividends received from public corporations because the dividends are paid from earnings that were subject to tax at the general rate applicable to such corporations.
A dividend is eligible only if it is designated as such in accordance with the rules in subsection 89(14) of the Act. At the same time, if a CCPC paying dividends designates them in a total amount that exceeds the CCPC’s GRIP, then the CCPC is required to pay a special penalty tax under Part III.1 of the Act. The regime is not unlike the one applicable to capital dividends. Ideally, then, a CCPC will do two things when paying an eligible dividend.
- The CCPC will follow the procedures prescribed by subsection 89(14) and the CRA in designating dividends. Subsection 89(14) provides as follows:
A corporation designates a dividend it pays at any time to be an eligible dividend by notifying in writing at that time each person or partnership to whom it pays all or any part of the dividend that the dividend is an eligible dividend.
The CRA, in a news release dated December 20, 2006, set out its views on what would amount to notification in writing for the purposes of subsection 89(14). The release stated in part that
For 2007 and subsequent taxation years, for all corporations other than public corporations, the notification requirements of proposed subsection 89(14) must be met each time a dividend is paid. Examples of notification could include identifying eligible dividends through letters to shareholders and dividend cheque stubs, or where all shareholders are directors of a corporation, a notation in the Minutes.
It is suggested that, if not all shareholders are directors, then shareholders could be asked to sign a simple acknowledgment at the bottom of the resolution declaring the eligible dividend.
- In our capital dividend resolutions, we include language about the belief of the directors respecting the amount of the capital dividend account and their intention to declare a dividend that will be received tax free by the payee. In part, the language is mandated by the requirements of the capital dividend election, but the language is also self-serving. For example, in an appropriate case, it might form the basis for a rectifcation order. An eligible dividend resolution should contain similar language.
