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moneysense.ca, 27/02/08
Dividend Taxes are Going up
Budget 2008 does have a sting buried deep in the document and barely mentioned in the mainstream media. In page 290, under the innocuous title of Dividend Tax Credit, the budget states:
The 2007 Economic Statement reduced the general corporate income tax rate to 15 per cent by 2012 and stated that consideration would be given to adjusting the enhanced DTC to ensure the appropriate tax treatment of dividend income.
Budget 2008 proposes to adjust the dividend gross-up factor and DTC rate for eligible dividends, to reflect those corporate income tax rate reductions.
Specifically, Budget 2008 proposes to reduce the eligible dividend gross-up from its current level of 45 per cent to 44 per cent effective January 1, 2010, 41 per cent effective January 1, 2011, and 38 per cent effective January 1, 2012. The enhanced DTC rate will also change on the same schedule, moving from 11/18 of the gross-up amount to 10/17, 13/23
and 6/11.
Translation: the dividend tax rate for the four federal tax brackets are increasing from -5.75%, 4.40%, 10.20% and 14.55% currently to -0.03%, 9.63%, 15.15% and 19.29% respectively by 2012, an increase of approximately 5% at every tax level. Ouch!
moneysense.ca, 27/02/08
Hi CC, Do you know if this dividend tax increase will affect dividends that are paid out of small business corporations (i.e. Canadian Controled Private Corporations)? Or does it only apply to dividends paid by public companies? Thanks in advance!
This is meant to nullify the effect of lower corporate taxes, not to increase the overall tax burden on dividend investors. The the combined effect of lower corporate taxes and higher dividend tax rates basically evens out at the end of the day.
An example with the 2nd tax bracket:
2007
Corporate: $100 – $19.5 (corp tax) = $80.50
Individual: $80.50(dividend) – $3.542 (div tax) = $76.958
2012
Corporate: $100 – $15 (corp tax) = $85.00
Individual: $85.00(dividend) – $8.1855(div tax) = $76.8145
… or a reduction of 0.186% after tax. Nothing to mourn about.
Note that when you factor in a slower ascent to higher tax brackets due to a smaller gross-up percentage, the overall effect is basically zero. i.e. a 38% grossed-up dividend will hit the next bracket slower than 45%.
Corporations have the option of distributing all the tax savings to shareholders, or reinvesting back to the business for future dividend increases. Either way, nothing is gained or lost in the context of after-tax total dividend return.
Plus, aren’t you going to be putting 20K of your income producing assets in to your TFSA by 2012 anyway? You won’t have to pay tax on any of that, so if you have 100K of assets then 20% of it will be tax free . . . it still looks great from a small investor (like me) who is just starting out.
CC,
So this only affects the federal portion of credits? I wonder if the provinces will follow?
Just wondering,
Tim
I agree with JF, it is a wash it just depends if the individual dividend paying companies are going to pass the taxes that they save along to their investors. I assume that there will be pressure for them to do that because at the end of the day passing those savings along to investors shouldn’t impact their business model…
Also, Traciatim makes a very good point, you can hide a good chunk of that dividend income in a TFSA by 2012.
Isn’t this similar to what they tried with the GST. The idea was to reduce taxes on corporations and then pass that on to consumers, with the idea that businesses would even out but it didn’t because businesses didn’t pass on their savings in the form of lower prices. Won’t corporations just keep the dividend the same and keep the tax savings as bonues to the biggest cheeses?
The difference between the GST and the dividend tax situation is that with the GST corporations were dealing with customers that they don’t really have any motivation to make completely satisfied. With the dividend situation they are dealing with investors that have way more clout than customers do. I think there will be some pretty strong pressure from the investment community to make sure at least some of the corporate tax cut makes its way into the hands of investors (unless the company has a really good use for that cash and can convince investors of that).
FJ: That’s exactly the rationale specified for the dividend tax increase. The cut in corporate taxes will wash out the increase in the dividend tax. I agree with you and 0xCC that most corporations are likely to boost the dividend to make up for the tax.
However, I disagree that it is a wash because pension plans and other tax deferred entities don’t pay taxes of any kind. That means they are likely to be willing to pay more for the same amount of dividends that a taxable investor is willing to pay. I’m guessing that future dividend yields will be correspondingly lower.
Rob: This increase is strictly for eligible dividends from Canadian corporations.
FJ: One more comment I wanted to make was that I for one was surprised by this tax. I thought that the corporate tax cut in the last fiscal update would benefit investors but this tax increase means that it is a wash (or maybe slightly negative).
It does seem stocks will probably get a one-time lift out of this, or maybe they already have since the market is forward looking. I’m not sure what % of dividend investors are registered vs non-registered. The lift would likely be negligible though. 2-3% perhaps?
I haven’t done the math, but I suspect British Columbians can still earn a substantial amount of dividends and not pay taxes; assuming no other incomes. My instinct is $45k’ish per spouse.
Traciatim: Good point. Personally, I can’t complain much since I only have a small percentage of assets in taxable accounts. Between RRSPs, mortgage pay down and RESPs there is little cash left for taxable investments. Now, add TFSA into the mix and it will be even harder to make taxable investments. Still, we’ve got to complain to keep life interesting, eh?
But if you have to hide away your Canadian dividend yielding stock in the TSFA, then you can’t use it to shelter your non-Canadian yielding stock (assuming that is permitted?). As the non-Canadian stock has no tax breaks, we are losing at least a bit on one front to gain on another aren’t we?!
Of course, this will all be a problem I’ll look forward to when RRSPs, RESPs, and TSFAs are all maxed out.
I am a bit fuzzy on one aspect of the TFSA. Say you invest some amount of money and some period of time later value has gone up (dividends, interest, gain… whatever) and you withdraw a portion, just what/how much can be replaced? The entire amount withdrawn or only some portion proportional in some way to your original contribution? This make any sense? Granted, this would probably only be much of an issue if you managed to max out TFSAs every year.
Double post, my bad. Sorry!
Pablito, the entire amount withdrawn adds to your contribution room. Check out this link:
http://www.budget.gc.ca/2008/plan/chap3b-eng.asp
“Withdrawals will create contribution room for future savings.”
“In addition, in recognition of the fact that most people are likely to have multiple savings objectives at the various stages of their lives—e.g. to purchase a car, home or cottage—the full amount of withdrawals may be re-contributed to a TFSA in the future, to ensure that there is no loss in a person’s total savings room.”
Someone may have done a more exact calculation but it looks like the increase in the dividend tax rate puts dividends pretty well on the same tax footing as capital gains except for the very lowest tax bracket (see Taxtips.ca ‘s table on the TaFSA for instance), i.e. for the taxable investor, that makes the two sorts of returns equally desirable from a tax perspective. If that’s the case, then the change makes life a little simpler since one doesn’t have to figure out whether to invest for cap gains / growth or dividend stocks in taxable accounts.