Dividend Gross-Up & Integration: A Practical Guide for Owner-Managers

New semester, new notebooks-and for Canadian law students stepping into tax, few topics repay early study like dividend integration. For owner-managers (and the students who will soon advise them), understanding how Canada grosses up dividends and then credits back corporate tax is table stakes for smart remuneration and corporate housekeeping.

Why integration exists

Corporate income is potentially taxed twice-once in the company and again in the shareholder’s hands. The gross-up and dividend tax credit (DTC) aim to make the combined corporate-plus-personal burden roughly equal to what an individual would have paid earning the income directly. Mechanically, the dividend is increased by a notional gross-up to approximate pre-tax corporate income, and a credit then imputes corporate tax to the shareholder. Perfect integration isn’t guaranteed across provinces or tax brackets, but the architecture is designed to get close.

Two dividend streams: eligible vs non-eligible

Dividends fall into two camps:

• Eligible dividends are designated from a corporation’s general rate income pool (GRIP)-income taxed at the general corporate rate-and are taxed more favourably to the shareholder. A corporation designates all or a portion of a dividend as eligible in writing at the time of payment; the Minister may accept a late designation (generally within three years) where “just and equitable,” with a longer window in certain transitional ERDTOH contexts.
• Non-eligible (ordinary) dividends generally come from income taxed at the small-business rate. Non-CCPCs must maintain a low rate income pool (LRIP) and are deemed to pay out non-eligible dividends until LRIP is cleared, before they can pay eligible dividends. (CCPCs track GRIP; LRIP is primarily a non-CCPC constraint.)

Year-end test for CCPCs: GRIP is calculated at year-end, but a CCPC may pay eligible dividends during the year as long as the total eligible dividends for the year do not exceed its GRIP at year-end. File Schedule 53 if you paid an eligible dividend or your GRIP changed.

Numbers to memorize

• Eligible dividends: gross-up 38%; federal DTC = 6/11 of the gross-up (equivalently, 15.0198% of the grossed-up amount as used on line 40425).
• Non-eligible dividends: for 2019 and later, gross-up 15%; federal DTC = 9/13 of the gross-up (equivalently, 9.0301% of the grossed-up amount). These settings were adjusted alongside the federal small-business rate reduction to 9% (effective Jan 1, 2019); provinces layer their own credits.

Because provincial credits and rates vary, “perfect” integration is uncommon-modest over- or under-integration is normal.

GRIP, LRIP and the “excessive eligible” trap

Paying eligible dividends without sufficient GRIP invites Part III.1 tax on excessive eligible dividend designations-20% of the excessive portion, or 30% on the whole designation where the anti-avoidance rule applies. Schedule 55 must be filed by every corporation resident in Canada that pays a taxable dividend in the year (other than a capital gains dividend), and an election is available to redesignate the excess as non-eligible-but not where the anti-avoidance rule in s. 185.1(2) applies. Practically, monitor GRIP at year-end and remember that policy-wise, only full-rate income should fund eligible dividends.

Holdcos, Part IV tax and inter-corporate dividends

Inter-corporate dividends are typically deductible to the recipient corporation (s. 112), but to prevent indefinite deferral when private/subject corporations receive portfolio dividends, Part IV imposes a refundable tax of 38 ⅓% on assessable dividends from non-connected payors (and on certain connected-payor dividends to the extent the payor obtained a dividend refund). This tax is refunded when the recipient pays its own taxable dividends, aligning corporate-level and shareholder-level taxation over time.

Since when do we track two RDTOH buckets?

For taxation years beginning after 2018, “refundable dividend tax on hand” splits into two accounts:

• ERDTOH tracks Part IV tax tied to eligible portfolio dividends (and certain connected-payor amounts that themselves generated an eligible-side dividend refund for the payer).
• NERDTOH tracks the refundable portion of Part I tax on a CCPC’s passive income (generally 30 ⅔% of aggregate investment income, subject to limits) plus Part IV amounts not already in ERDTOH.

Refunds are triggered by dividends paid: eligible dividends refund ERDTOH; non-eligible dividends first refund NERDTOH, then-if there’s still room-may also unlock ERDTOH under the ordering rule in s. 129(1)(a)(ii). The classic thumb rule is a refund of 38 ⅓% of taxable dividends paid, capped by the relevant RDTOH balance(s).

Putting it together: a road map for owner-managers

• Map the source: GRIP (full-rate) versus small-business income or other low-rate income (LRIP is mainly a non-CCPC concept).
• Match the designation: pay eligible from GRIP; non-eligible when distributing low-rate income (or when LRIP must be cleared in a non-CCPC).
• Before declaring eligible dividends: confirm year-end GRIP to avoid Part III.1 exposure (redesignation election exists but is unavailable if anti-avoidance applies and requires formalities).
• Using a holdco? Expect Part IV on portfolio dividends; plan downstream dividends to trigger refunds efficiently.
• Track ERDTOH/NERDTOH so the right dividend type unlocks the right refund in the prescribed order.
• Expect slight integration “noise”: neutrality is a goal, not a promise.

Educational Tip (for week one)

Take $100 of corporate income and trace it three ways (post-2018 settings):

1. taxed at general rates, then paid as an eligible dividend;
2. taxed at small-business rates, then paid as a non-eligible dividend; and
3. earned as passive investment income in a CCPC, generating NERDTOH and later refunded on a non-eligible dividend.

Use: 38% gross-up with a 6/11 federal credit for eligible; 15% gross-up with a 9/13 federal credit for non-eligible; and a 38 ⅓% refund rate under s. 129, subject to your ERDTOH/NERDTOH balances. This exercise forces you to see how the gross-up rebuilds pre-tax corporate income and how the DTC and refund mechanisms bring personal-plus-corporate tax back toward the direct-earning benchmark.

Quick reference (forms & pages)

• Schedule 53 (GRIP), Schedule 54 (LRIP), Schedule 55 (Part III.1).
• CRA Line 40425 (individual federal DTC percentages).

Bottom line

In the fall rush of resolutions and year-end prep, owner-managers who match dividend designations to income pools, keep an eye on GRIP/LRIP, and coordinate ERDTOH/NERDTOH with holdco cashflows will avoid “excess eligible” surprises and keep integration working as designed.