Know the Tax Implications of Dividend Income

If you are planning to buy shares in a company in the hope of receiving regular dividend payments, take some time to review how the Canada Revenue Agency (CRA) taxes income from directly held shares.

The first step is to realize that your tax bill on dividend income will depend on where the company is located. The CRA treats domestic and foreign dividend income differently.

For a conservative portfolio, you might look for disciplined, well-run, profitable companies that have a record of regularly boosting their payouts.

You can find blue-chip stocks that provide yields competitive with short-term bonds and Guaranteed Investment Contracts.

But remember, companies can cut their dividend outlays for any number of reasons and that can cause the stock’s price to slide.

Domestic Dividend Income: If you own shares in a taxable Canadian corporation, you are eligible to take a dividend tax credit aimed at preventing double taxation. Dividends are paid out of a company’s after-tax earnings, which means that when you get your payout, the company has already paid taxes on it.

Foreign Dividend Income: Taxation is more complicated when you receive dividends from a foreign company, although you may be eligible for a foreign tax credit. The tax due on foreign income is based on treaties between Canada and the countries where the companies are domiciled. Generally, Canadians will pay tax on foreign dividend income in Canada and get credit for foreign taxes withheld.

More than 750,000 Canadians hold U.S. investments directly or through a registered account. American companies generally withhold taxes on your dividend payments but the exact amount depends on whether you certify that you are a Canadian resident. When your Canadian tax return is prepared, you may receive a foreign tax credit.

The tax credits for Canadian dividends make them a very tax-efficient source of income for most Canadian investors.

Taxation of dividend income can be complicated and it’s best to consult with your tax adviser, who can ensure you pay the least amount of tax possible.