As many readers know, “eligible dividends” received by Canadian resident individuals are taxed preferentially as compared to non-eligible dividends. First introduced in 2006, the legislation dealing with eligible dividends is complex and detailed.
An “eligible dividend” is defined in subsection 89(1) of the Income Tax Act (the “Act”) as a “taxable dividend” that was: (i) paid by a corporation resident in Canada after 2005 and designated as an “eligible dividend” pursuant to subsection 89(14), and (ii) received by a person resident in Canada.
In accordance with subsection 89(14), corporations have to designate each eligible dividend that it pays at any time to be an eligible dividend by written notification at that time to each shareholder to whom it pays an eligible dividend.
In the 2006 taxation year, the CRA accepted eligible dividend designations and notifications based on the identification of such eligible dividends on the actual T3 and T5 slips that were issued by the payors. Other acceptable methods included posting the notice on the corporation’s website or in corporate publications.
The above 2006 administrative position was due to the fact that the eligible dividend legislation had not yet received Royal Assent (enacted). The coming into force provisions provided that notification made by May 22, 2007 for any dividends paid before February 21, 2007 would comply with subsection 89(14).
Subsequent to the enactment of the eligible dividend legislation, including subsection 89(14), the above timing issue was no longer relevant. Accordingly, the CRA no longer accepts that simply reporting the dividends as eligible dividends on the T3 and T5 slips is an acceptable method of notification that a dividend has been designated as an eligible dividend.
In taxation years subsequent to 2007, all corporations, other than public corporations, must meet the notification requirements set out in subsection 89(14) of the Act. The CRA’s administrative policy (which appears consistent with the legislation) is that the notification must be made before or at the time the dividend is paid using an acceptable notification method. Examples of notification could include identifying eligible dividends through letters to shareholders and dividend cheque stubs, or where all shareholders of a corporation are Directors of the corporation, the notification could be made in the Minutes of the corporation. The CRA recently reiterated its position at the 2008 National Tax Conference of the Canadian Tax Foundation that a simple disclosure on the T5 and T3 slips is not sufficient to meet the conditions of subsection 89(14).
Notification of a designation must be given to all shareholders who receive an eligible dividend, including those whose mailing address is outside the country, and even if non-resident withholding tax (Part XIII tax) is withheld from the payment. A dividend received by a non-resident shareholder cannot qualify as an eligible dividend.
All shares of a particular class of shares have the same attributes and therefore, a designation of eligible dividends must include all the shareholders of that class. A designation will not be accepted in respect of the portion of the dividend paid to certain shareholders of a class of shares.
Late designations are not permitted under subsection 89(14) pursuant to section 600 of the Income Tax Regulations, which also supports the view that Parliament intended to provide taxpayers with certainty as to the tax implications of corporate distributions. However, this can cause significant practical problems when designating taxable dividends to be eligible dividends.
Where the notification to shareholders do not specify the amount of the “eligible dividend” to each shareholder, the requirements of subsection 89(14) will not be met because they did not specify the amount of the eligible dividends to each shareholder when paid. Therefore, a simple statement by a corporation that a dividend will not exceed the company’s general rate income pool (“GRIP”) will seemingly not satisfy the designation requirement for eligible dividends.
A textual, contextual and purposive review of subsection 89(14) reveals that the taxpayer’s entitlement to a written and contemporaneous notification each time a dividend is paid underlies Parliament’s intent to provide dividend recipients with certainty regarding the tax consequences of corporate distributions. However, as previously noted, this can cause significant practical problems for accountants, lawyers and their clients. Caution!