Dividend tax credit

The dividend tax credit exists because Canadian corporate dividends are paid out of after-tax corporate earnings — meaning the income has already been taxed once at the company level. To avoid double-taxing the same dollar, Canada's tax system grosses up the dividend at the personal level, applies the personal rate, then credits back an amount meant to approximate the corporate tax already paid.

Two categories of Canadian dividend exist. "Eligible" dividends — from most large public Canadian corporations — receive a larger gross-up and a larger offsetting credit, leaving a lower effective tax rate. "Non-eligible" (or "other-than-eligible") dividends — typically from Canadian-controlled private corporations paying out of their small-business-rate income — receive a smaller gross-up and credit.

The net result is that eligible Canadian dividends are the most tax-favoured form of investment income for non-registered account holders at most middle-income brackets. Interest income is taxed at full marginal rates; capital gains are taxed at the inclusion rate times marginal rates; eligible dividends sit below that for many taxpayers.