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Fredericton Daily Gleaner ~ Capital Appreciation ~ Hidden Dividend Tax ~ October 2, 2006 - 29 Oct 2006 by TaxHelp
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Now that we have flipped the page of the calendar and are truly into the fourth quarter of 2006, we can look a little closer at a tax anomaly I touched on last week that had some New Brunswickers paying significantly more to Fredericton. The interesting thing is that it wasn’t a tax increase, and so the government of the day didn’t have to face a barrage of criticism.
On December 10, 2002 the Progressive Conservatives brought down their provincial budget. In it, they trumpeted the fact that they had lowered personal taxes in every year of their mandate. While that sounds great, the budget in question also raised gasoline taxes and tobacco taxes – not a personal tax increase but by their very nature this had an impact on anyone who drove or smoked or both.
But more insidious than those two items was the change to the way the province taxed individuals in receipt of dividends from corporations. This budget announced continued reductions in both the general corporate income tax rate and the small business tax rate. While no doubt these were attractive measures to some, most investors in the province in receipt of dividend income earn these returns from the large central Canada institutions like the banks.
So buried in the budget was an announced change to the dividend tax credit, effective January 1, 2003. The government reduced this credit from 7.6 per cent to 3.7 per cent. I remember commenting at the time how this would go unnoticed and with little protest, at least for the next year or longer.
The announced measure was in December of 2002, effective for the 2003 tax year, where most people wouldn’t notice until the spring of 2004 when they file their tax returns.
The dividend tax credit mechanism was instituted as a way to avoid the double taxation that an investor faces. A corporation has their profits taxed. These profits are then taxed again as dividends when taken by the shareholder. The mechanism works this way: the dividend is increased by 25 per cent and reported on the tax return. The federal government then generates a tax credit of 13.3 per cent. The province prior to 2003 had a credit of 7.6 per cent.
In real numbers, in 2002, someone earning $50,000 in dividends only, reported $62,500 on their return and then paid $2,294 in taxes to Ottawa and $2,145 to Fredericton. The following year, with the reduction in the provincial tax credit, the same person paid $2,244 to Ottawa and $4,544 to Fredericton – more than double! So while the government was able to proclaim that it wasn’t a tax increase, it sure felt that way to some.
Why the history lesson? Last November, then federal Finance Minister Ralph Goodale announced changes to the way this mechanism was going to work in face of the popularity and tax advantages of income trusts. He stated that the gross-up amount for large corporation dividends was increasing from 25 per cent to 45 per cent and the enhanced tax credit was going from 13.3 per cent to 18.97 per cent. In his May budget, current Finance Minister Jim Flaherty confirmed this.
If we revisit the above taxpayer, in 2005 the $50,000 in dividends was again reported as $62,500 on the return. The federal tax had now decreased to $1,627 – a savings of over $600 over the two years, while the provincial tax was $4,503 – not even $50 less during the same time period.
This year with the new changes, the $50,000 now is reported as $72,500 but the federal tax bill is just $252. So the big question is “What rate is Fredericton going to set for the enhanced dividend tax credit in light of these changes?” Some people would suggest that it should return to the same relative rate as before. Depending on who is doing the calculating, that could be anywhere from 10.5 per cent to 12 per cent. We will just have to wait and see how the new government handles this challenge.
Roger Haineault is with Help 4 Taxes. He can be reached by email at roger@help4taxes.ca or by calling 1 (888) 450-1212. His column appears Mondays.
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