What the Dividend Tax on Banks Means for You
By PAIP Canada staff
Unless you’re a shareholder of a Canadian bank, the short answer is nothing. If you own shares in a bank, the answer is probably still nothing, but now for the long answer.
When an individual investor receives dividends from any publicly traded company, the standard methodology for tax reporting is to gross up the amount received by a factor of 1.38, and be given a Federal and Provincial dividend tax credit (DTC) computed as a percentage of the taxable dividend. In theory, the DTC is supposed to be equal to the tax paid at the corporate level (on the underlying income). Essentially this “backs out” the taxes paid by the company (on its corporate profits), and instead allows each investor to pay taxes at their own marginal rate of tax. To compensate for this gross-up, both the federal and provincial governments provide a tax credit to offset the taxes previously paid by the company. For investors, this means dividend income is effectively taxed at a lower rate than other investment income such as interest. Let’s not forget that a tax credit reduces the amount of taxes one must pay.
Where the new budget applies, is in regards to the tax treatment of dividends received by banks. Although most companies are taxed on dividends received by passive investments, Canada’s banks sometimes differ. Since they sometimes need to hold shares in other publicly traded companies to run their business, they were previously given a tax exemption on the dividends received from these shares.
As an example, when a client at the banks’ discount brokerage arm purchases shares of a highly liquid company, the discount broker often has an inventory of shares to offer their clients. They do not always have to go to the market and transact with a third party which would be more expensive.
Although the retail client benefits by receiving shares out of the banks’ inventory, the government (and taxpayers) have decided that they’re not receiving their fair share. What was previously omitted from taxation (dividends received on shares in inventory) will now be subject to taxation.
The net impact will be more tax revenues for the government, and a small decline in net income for Canada’s banks.