Important changes to the taxation of dividends were enacted earlier this year that affect the manner in which dividends paid by Canadian corporations must be documented. These new requirements include important notification deadlines for dividends paid in 2006 and require that future dividends be accompanied by written notices to shareholders at the time dividends are paid in order to be eligible for special tax treatment.
The concept of “eligible dividends” was introduced for taxable dividends paid by Canadian-resident public or private corporations during 2006 and thereafter. The enabling legislation received royal assent on February 21, 2007.
In summary, eligible dividends received by Canadian residents enjoy preferred tax treatment. The maximum personal tax rate applicable to an eligible dividend in 2006 is 25.09 percent in Ontario and 18.18 percent in Alberta. An ordinary (non-eligible) dividend, on the other hand, is subject to a maximum personal tax rate in 2006 of 31.34 percent in Ontario and 24.58 percent in Alberta.
The ability to pay an eligible dividend depends upon a number of circumstances and generally ties into the nature of the income earned by the corporation paying the dividend and the rate of tax paid by the corporation on such income.
A corporation otherwise able to pay an eligible dividend must designate the particular dividend as an eligible dividend and must notify the recipient shareholder in writing that the dividend is an eligible dividend at the time the dividend is paid. In respect of dividends paid before February 21, 2007, designation and notification must be made on or before May 22, 2007 (i.e. 90 days after royal assent). For dividends paid on or after February 21, 2007, the designation and notification must be made at the time the dividend is paid, and there is no 90-day grace period. These deadlines apply to dividends paid to any shareholder, including dividends paid by a subsidiary to a parent corporation or trust, including a mutual fund trust in an income fund scenario.
The most direct approach is to designate the dividend as an eligible dividend in the resolution authorizing the dividend and to include written notice on the cheque paying the dividend. For 2006, the designation and notification can be based on identification of the eligible dividends as such on the T3 and T5 slips issued by the payer. A public corporation may also post a notice that dividends are eligible, unless otherwise indicated, on its website (such notice being valid until removed), in its quarterly or annual reports (such being valid for that quarter or year), or by way of a press release. The shareholder is entitled to rely on such notice and need not be concerned with the status of the dividend for tax purposes.
As 2006 is the first year for eligible dividends, many corporations may be unaware of the opportunity to pay dividends as eligible dividends and/or the rules and time limits for making the designation and notification. Again, the deadline for the notification for 2006 is May 22, 2007, so it is essential to review dividends paid last year and make the required designation. Eligible dividends paid on or after February 21, 2007, must be designated as such at the time of payment. A practice of documenting the declaration and payment of dividends with a prior effective date based on instructions received from the corporation or its accountants after the effective date may result in the dividends that would otherwise be eligible dividends being disqualified from the lower rate of tax.
In every instance where a corporation has paid a taxable dividend since January 1, 2006, the corporate resolutions should be reviewed at the earliest opportunity to determine if the directors have designated the dividend as an eligible dividend or otherwise evidenced that they were aware of the option to do so. If the intent is to qualify dividends paid in 2006 as eligible dividends, a notice to that effect must be provided in writing to shareholders. This must be done by May 22, 2007. Dividends paid this year must be accompanied by an appropriate designation and written notification to shareholders. It is important to meet the designation and notification rules and deadlines because an eligible dividend designation cannot be made late, nor can it be amended or revoked.
It may also be appropriate to review the existing share structure for many corporations to see if there are ways to maximize the benefit of the payment of eligible dividends. Included in this review may be an analysis of existing and future unanimous shareholders agreements, particularly as buy-sell provisions are concerned.
For further information, please contact any member of our tax department.