What new investors must know: what's the dividend tax credit?

If you're looking to maximize return on your investment income and pay less taxes, could the dividend tax credit be the answer or does it have a downside? Here's what you should know.

What new investors must know: what's the dividend tax credit?

The dividend tax credit is a rebate that gives individual investors a break on the taxes a company has already paid on its profits.

How does the dividend tax credit work?

A company must pay taxes on the income that it makes. However, companies also tend to pay their investors dividends.

  • Since the company has already paid taxes on those gains, it wouldn’t be fair for the government to collet them again from investors.
  • That’s why the Canadian government created special rules around corporate dividends through the Dividend Tax Credit.

Who qualifies for the dividend tax credit?

Investors typically qualify for the dividend tax credit when they receive dividends from the traditional (eligible) sources such as public companies, banks and utilities.

  • The tax credit also applies to preferred shares.

Advantages of the dividend tax credit

The rebate reduces your tax burden and is especially useful for those with lower taxable income.

Disadvantages of the dividend tax credit

On the downside, the dividend tax credit only applies to dividends from Canadian companies, so it’s not available if you’re investing in U.S. or overseas companies.

  • It’s also important to look at how this rebate may interact with the other investments you have and whether it could accidentally push you into a higher tax bracket.

Why you should take advantage of the dividend tax credit

The dividend tax credit means you pay less taxes and get to keep more of what you make from your investment returns.

  • This is crucial for any Canadian wanting to maximize the income he or she makes from investments.
  • Many of the companies paying out dividends return that money to their investors because they’re doing well, so they naturally wind up becoming attractive investment opportunities.

Some final thoughts

Overall, the dividend tax credit is a useful tool to reduce the tax burden on investors, but it only applies to dividends from Canadian companies and is most effective at certain tax levels.

  • As a tax strategy, it’s worth taking advantage of, but should be looked at in conjunction with all of your holdings to ensure it’s being used in the most effective way.

Smart Tip provided by The Financial Pipeline. Founded in 1996 by a group of portfolio managers, The Financial Pipeline is dedicated to providing financial knowledge and education to anyone and everyone with even a passing interest in finance. Our motto, “Financial Information For the Rest of Us,” speaks for itself.

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