Wednesday, August 30, 2006

Dividend Tax Credit for 2006 & On

  
GlobeinvestorGOLD, Gordon Pape, 30 August 2006

It appears that many people aren’t taking advantage of the great investment opportunities created by the overhaul of the dividend tax credit earlier this year. If you’re in that group, it’s time to update your approach and start thinking seriously about switching some of your non-registered money to dividend-paying securities. You’ll be amazed at how much more cash will end up in your pocket after tax, especially if you’re sitting on a lot of bonds and GICs.

I suspect that part of the problem is the confusion that surrounded the sea change in the way dividends are taxed in Canada. The plan was first put forward by then-Finance Minister Ralph Goodale shortly before the fall of the Liberal government and the election call.

Goodale proposed to virtually (but not completely) eliminate double taxation on corporate profits by enhancing the dividend tax credit for individuals. His complex plan involved increasing the “gross-up” of actual dividends paid to 145 per cent (from 125 per cent) and raising the ensuing tax credit to 19 per cent of the grossed-up amount (from 13.33 per cent). The new formula was to apply only to dividends from large corporations; payments from firms taxed at the small business rate would continue to be treated in the old way.

The enhanced dividend credit was actually a fall-back position after the blow up of the government’s plan to impose new taxes on the burgeoning income trust industry. Faced with the prospect of going into an election with much of the 60+ demographic in high dudgeon over the collapse in trust valuations, Goodale retreated to Plan B, saying an enhanced dividend tax credit would “level the playing field” with trusts.

The revised formula went into effect at the federal level on Jan. 1, right in the middle of the election campaign. The problem was that no one knew if it would stick and when the Conservatives came to power the doubts grew. Many provincial governments deferred taking steps to harmonize their dividend tax structure with the Goodale formula while they waited for the first Tory budget.

That finally came in May with the new Finance Minister, James Flaherty, endorsing the Goodale plan. After that, most of the provinces began to fall in line with the biggie, Ontario, recently giving its blessing.

But now that the upgraded tax credit is firmly in place, few people seem to understand just how much money it can save them. Let me give you some examples, courtesy of the excellent tax calculators on the website of Ernst & Young Canada. If you’d like to check your personal situation, go to http://www.ey.com/global/content.nsf/Canada/Tax_-_Calculators_-_Overview

Let’s start with someone in the top bracket. The rates vary dramatically from one province to another, but the highest rate that a high earner will pay on a dollar of dividend income is 32.09 per cent in New Brunswick. By comparison, the same dollar earned as interest will attract a rate of 46.84 per cent in that province.

An Alberta resident in the top bracket will pay only 14.65 per cent on dividends versus 39 per cent on interest income. For high-income Ontario residents, the figures are 25.09 per cent for dividends and 46.41 per cent for interest. One of the fascinating anomalies of the new system is that dividend income is actually taxed at a lower rate than capital gains in several provinces, including Alberta, Saskatchewan, Nova Scotia, and Prince Edward Island.

Here’s something else that’s intriguing. The lower your income, the more effective is the new dividend tax credit. An Alberta resident with $60,000 in taxable income will pay tax at a rate of only 4.5 per cent on dividends. Saskatchewan is close behind at 5.25 per cent. In all, six of the 10 provinces and all of the Territories have single-digit tax rates on dividends at this income level. Quebec, New Brunswick, Newfoundland, and Nova Scotia are the ones that are out of step.

Drop down even further to taxable income of $30,000 and British Columbia, Saskatchewan, Manitoba, Ontario, PEI, and the Territories give you the money free! The effective tax rate in those jurisdictions is zero, and Alberta is close with a rate of 0.1 per cent.

The implications of this are significant. Low- to middle-income people with a little money to invest should put it all into dividend-paying securities. To heck with GICs! It’s time for a new mind-set!
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