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The dividends you receive from Canadian Corporations can be of two types - eligible dividend and ineligible or non-eligible dividend. Eligible dividend is one which is eligible for an Enhanced Dividend Tax Credit. On the other hand, ineligible dividends are not eligible for this credit.
Typically, ineligible dividend is the dividend you receive from CCPCs or Canadian-controlled private corporations, which they pay out of their income taxed at the small business rate. Sometimes, even large public corporations may declare a portion of their dividends as ineligible. While these dividends are not eligible for the enhanced dividend tax credit, they are eligible for some federal and provincial dividend credits.
Let's look at how the taxation works for ineligible dividend and the calculation of credits.
Starting in 2014, the gross-up rate for ineligible dividends is 118%. So if you earn $500 as ineligible dividend, you need to report $590 ($500 x 118%) as your taxable income.
The federal government provides a credit of 11.017% of the grossed-up dividend or 13% of the actual dividend. So for a gross-up amount of $590 you are eligible for a credit of $65 (11.017% of $590 or 13% of $500).
Based on the province, ineligible dividends are eligible for a credit in the range of 0.83% to 7.05% of the grossed-up amount or between 0.98% to 8.319% of the actual dividend. For instance, if you're a resident of Manitoba, on a dividend of $500you can get a credit of $4.89 (0.83% of $590 or 0.98% of $500).
Here's how the combination of both these tax credits would work out for taxation purposes. To continue from the above example, suppose you are a resident of Manitoba, and you fall under the marginal tax rate of 20%. Your approximate tax on this dividend will be $118 ($590 x 20%). But since you have received total dividend tax credits of around $70 (both federal and provincial combined), your tax liability on the ineligible dividend will only be $48 ($118-70).
Ineligible dividends constitute a part of your taxable income and are subject to federal and provincial taxes and credits. You can calculate the tax on ineligible dividends and their effect on your income on the Tax Calculator (select advanced tax calculator options for Ineligible Dividends).