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Small change to the eligible dividend rules

On July 14, 2008, The Department of Finance released a package of proposals to amend the Income Tax Act for various measures. Included in the package was a small amendment that proposes to tinker with the eligible dividend rules.

For readers that are familiar with the eligible dividend rules, such persons will know that eligible dividends are paid out of a Canadian Controlled Private Corporation’s (”CCPC”) General Rate Income Pool (”GRIP”). To the extent that a shareholder of a CCPC receives an eligible dividend, the taxation of such an eligible dividend is at a reduced rate compared to that of a non-eligible dividend. For example, in Alberta, the highest tax rate on an eligible dividend for 2008 is 16%. For 2009, the tax rate on an eligible dividend reduces to 14.55% and for years after 2009 the tax rate will creep back up finally landing in 2012 at 20.85%. Accordingly, such tax rates are very attractive as compared to that of non-eligible dividends which for 2008 compares at 26.46%.

A CCPC’s addition to its GRIP pool is calculated pursuant to a formula that is contained in subsection 89(1) of the Income Tax Act. The formula is quite complex. Very generally, the policy intent of the definition of GRIP is to add the estimated after-tax income of the CCPC that has been subject to the highest corporate income tax rate. Presently, the addition to the GRIP is set at a rate of 68% of the CCPC’s high rate taxable business income. The intent of the 68% factor is to reflect an estimated 32% combined federal-provincial income tax rate that the CCPC would have been subject to. However, the 32% tax rate is actually high given that corporate tax rates are being aggressively reduced over the next number of years. For example, in Alberta, the highest tax rate applicable to a corporation on its business income is 29.5% for 2008. This rate is continuing to fall and will eventually land at 25% in 2012. Accordingly, for an Alberta resident corporation in 2012, one would expect to add 75% of its taxable income that has been subject to the highest tax rate to its GRIP. However, presently the law only allows 68% of the after-tax income to be added to its GRIP. The Department of Finance was aware of such a discrepancy and in its package of proposals released on July 14 proposes to increase the 68% inclusion rate to 72% over a four year period. Specifically, The Department of Finance proposes to increase the 68% rate as follows:

2009 68%
2010 69%
2011 70%
2012 and after 72%

While this is a significant improvement, Alberta resident corporations will still not be able to add all of its high rate after-tax income to its GRIP. Theoretically, given the policy intent of the eligible dividend rules, one would expect that an Alberta resident CCPC should be able to add 75% of its after-tax income to its GRIP. However, as can be seen above, such a CCPC will only be able to add 72% to its GRIP.

Notwithstanding, the proposals of July 14, 2008 are welcome!