How the “Gross Up” and Dividend Tax Credit Work
Under the current income tax system, income earned by corporations is taxed at the
corporate tax rate. If that income is paid out as dividends to individuals, it is taxed again, at
the personal tax rate. Without any other measures, this would result in double taxation.
To address this, the tax system uses two mechanisms: the “gross up” and the dividend tax
credit. Therefore, if we assume a corporation earns $100 in income, and pays out all the
after-tax amount in dividends, the corporation will pay 30.5 per cent, or $30.50, in income
tax and distribute $69.50 in dividends.
The individual receiving the $69.50 in dividends “grosses up” his or her income by 125 per
cent, and reports $86.90 in income. This is intended to approximate the before-tax income
of the corporation. Assuming a personal tax rate of 43.05 per cent, the individual is liable
for $37.40 in tax on this income.
The individual is then eligible to claim a Dividend Tax Credit of 19 1/3 per cent of the
grossed up amount, or $16.80, for a net tax liability of $20.60
The total tax paid by both the corporation and the individual is $51.10.