The tax system in Canada aims for income from salaries and dividends to generate the same after-tax cash in the hands of individual shareholders. This goal is achieved through a concept known as integration.
Tax on salaries -is withheld and paid to the CRA regularly throughout the year. -This reduces the amount of tax payable upon filing an annual return and -minimizes the need for quarterly tax instalments.
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Actual Dividends
Actual dividends, also known as cash dividends, are the tangible returns that investors receive directly in the form of cash payments. These dividends represent a share of a company’s profits distributed to its shareholders, providing them with a regular income stream. Companies typically issue actual dividends quarterly or annually, and investors often view them as a reliable source of passive income.
One of the key advantages of actual dividends is their liquidity. As cash payments, investors can use these dividends as they see fit, whether it’s reinvesting in the same company, diversifying their portfolio, or simply covering living expenses. The simplicity and flexibility of actual dividends make them an attractive option for income-oriented investors.
Taxable Dividends
While taxable dividends provide a straightforward income stream-, it’s essential to understand the tax implications associated with taxable dividends. Taxable dividends are the grossed-up amount of actual dividends that are subject to taxation.
In Canada, the taxation of dividends is influenced by the dividend gross-up and tax credit system, designed to account for the corporate taxes already paid by the issuing company.
The gross-up process involves increasing the taxable amount of the dividend by a set percentage, reflecting the corporate taxes paid by the company. While this may seem like a disadvantage at first glance. It plays a crucial role in reducing the overall tax burden for eligible investors.
The gross-up system effectively recognizes that the company has already contributed to the tax pool, resulting in more favourable tax treatment for individuals.
What Are T5 Slips?
T5 slips are used to report investment income to the Canada Revenue Agency. This includes income from dividends, interest earned on savings accounts, bonds, and royalties. The T5 slip indicates different types of income in various boxes.
The T5 slips should be issued by the financial institution where you hold your investments. If you don’t receive your T5 slips, you can check the status on CRA My Account or ask your tax accountant to look into it for you.
The dividends are reported on the T5 slips which are filed by the shareholders (owners) with their tax returns at the end of the year. The T5 information return is much simpler than a T4 slip for employment income. Since there’s no need to register with the CRA, calculate and remit withholding taxes on each payroll or even keep track of each month’s withholdings for remittance purposes.
Tpes for Dividends5 Slip B
When it comes to dividends, different box types on the T5 slip signify distinct information about the income received.
- Box 10 – Actual amount of dividends other than eligible dividends: Reports dividends other than eligible dividends paid by Canadian corporations -, and subject to withholding tax.
- Box 11 -Taxable amount of dividends other than eligible dividends: Indicates the grossed-up number of dividends other than eligible dividends that must be reported as income.
- Box 12 – Taxable amount of dividends other than eligible dividends: Reports the tax credit for dividends other than eligible dividends.
- Box 13 – Interest from Canadian sources: sources: Reports interest from Canadian sources.
- Box 15 – Foreign Income: Indicates the gross amount of foreign income in Canadian currency subject to Canadian tax rules.
- Box 16- Foreign tax paid: Reports the foreign tax paid in Canadian currency, often eligible for a foreign tax credit that can be used to reduce double taxation.
- Box 24 – Actual amount of eligible dividends: Reports eligible dividends paid by Canadian corporations, and subject to withholding tax.
- Box 25 – Taxable amount of eligible dividends: Indicates the grossed-up amount of eligible dividends that must be reported as income.
- Box 26 – A dividend tax credit for eligible dividends: Reports the tax credit for eligible dividends.
Understanding each T5 slip box type is crucial for accurate tax reporting and effective financial planning.
Why Are “Taxable Dividends” More Than “Actual Dividends”?
When you receive dividends (other than capital dividends) from a Canadian corporation, you are taxed on them at both the federal and provincial levels. They are considered taxable because they are being paid from the profits of a company that has decided not to reinvest them into new income-generating assets. The amount you receive in a dividend payment will be shown on your T5 slip.
1. Gross-up of Dividend to Taxable Amount
Corporate profits paid out as dividends are taxed at both the corporate and personal levels. To minimize the double taxation that this entails, there is a gross-up and credit system at the personal level that considers the corporate tax already paid. The actual dividend paid by a Canadian corporation is therefore grossed up to reflect the amount of profits earned before the application of corporate tax. The dividend tax credit offered by both the federal and provincial governments together should be equal to the amount of the gross-up but may not be because each province decides on the size of its dividend tax credit. As a result, there could still be some double taxation.
Compensated by Salary or Dividends
If you own a small business, deciding whether to pay yourself dividends or salary is important. Both have advantages and disadvantages, and both will affect the income tax you will pay in Canada. You should consider your future goals, current personal and corporate tax situation, and income sprinkling potential when making this decision.
Choosing between dividends and salary is often not a straightforward decision for a business owner. This is because of the different tax rates and potential future considerations. For example, if you plan to -contribute to an RRSP, you may find it more beneficial to take a salary because this will allow you to maximize the amount of before-tax money that can be invested in your RRSP each year.
Another factor to consider is the difference in the tax rates for eligible and non-eligible dividends. Eligible dividends are paid out of income that has been taxed at the general corporate rate. While non-eligible dividends are paid out of income taxed at the small business corporate rate.
While there are a variety of factors to consider, the best option for your small business will ultimately depend on your personal and corporate goals. Whether you are compensating yourself by dividends or salary, it’s important to consult a professional at FaberLLP to make an informed decision that will minimize your taxes and maximize your earning potential.