Proposed Regime for Personal Tax on Dividends - Implications for CCPCs

Legislation implementing this announcement has yet to be released, so taxpayers will want to keep apprised of the status of the announcement and whether any changes are made to it.

The Changes

The tax reduction will apply to dividends paid after 2005 by CCPCs, to the extent that the CCPC’s income is:

• net investment income (other than dividends from public companies); and
• subject to the general federal corporate income tax rate

It will also apply to dividends paid after 2005 by:

• public corporations; and
• other corporations that are not CCPCs that are resident in Canada and are subject to the federal general corporate income tax rate (ie. 22.12% in 2006).

The result is that the top federal personal income tax rate on qualifying dividends will drop from 19.58% in 2005 to 14.5% in 2006, a decrease of 5.08%. This reduction will be implemented for qualifying dividends by increasing both the dividend gross-up (from 25% to 45% of dividends received) and the federal dividend tax credit (from 13.33% to 19% of grossed-up dividends).

The federal government’s objectives will be met only if the provinces and territories follow the federal lead and make similar reductions to their personal income taxes on dividends. The federal government assumes this will be the case.

Objectives

The changes are intended to make the tax treatment of distributions from corporations and those from income trusts and other flow-through entities more equitable. The announcement shows that, while income subject to the general corporate tax rate is taxed at a combined corporate and top personal tax rate of 54% in 2005 after being distributed as dividends, the rate will drop to 46% in 2010, provided the government’s plans to reduce the federal general corporate rate to 19% by 2010 are passed. Until 2010, however, the combined corporate and personal tax burden will exceed 46%. For example, in 2006 the combined tax rate will be approximately 49%.