Alberta residents should expect a tax increase for eligible dividends in 2021.

On June 29, 2020, the provincial government of Alberta announced it would accelerate a previously-announced change to the corporate tax rate for regular business income, reducing it from 10% to 8%, effective July 1, 2020.

When corporate tax rates are reduced, it is common to see a corresponding increase in the dividend tax rate. On October 20, 2020, the Alberta government introduced the legislation to implement the corporate tax rate reduction. At the same time, the government proposed to reduce the eligible dividend tax credit, effectively increasing the personal tax rate on eligible dividends received by residents of Alberta on or after January 1, 2021.

What are the new tax rates?

The new legislation proposes to reduce the dividend tax credit for eligible dividends, effective January 1, 2021. In 2020, when an Alberta resident receives an eligible dividend, they are entitled to a tax credit of 20.7% of the dividend to apply against their federal taxes and 13.8% of the dividend to apply against provincial taxes. Beginning in 2021, this provincial tax credit is reduced to 11.2%.

Because the dividend tax credit reduces taxes payable on a dollar-for-dollar basis, this 2.6% reduction in the eligible dividend tax credit is effectively the same as a 2.6% increase in the eligible dividend tax rate. The following chart outlines the new effective tax rates for eligible dividends in each provincial tax bracket, starting in 2021:

The above tax brackets are applicable for the 2020 taxation year. Please note that most of the brackets will increase slightly for 2021, as federal tax brackets are indexed to inflation.

How are business-owners affected?

Not every business owner will benefit from the new business tax rate. The new business tax rate of 8%, applicable from July 1, 2020 onwards, only applies to income that is ineligible for the small business deduction. In most cases, this refers to businesses whose income (across the entire corporate group) exceeds $500,000 per year, and applies only to business income above that level.

The new tax rate may also affect corporate-owned investments. In previous years, passive investments were taxed at rates of up to 50.67% for interest income and 25.33% for capital gains. With the new, lower corporate tax rate, this investment income may now be taxed more favourably, at rates of 46.67% for interest income and 23.33% for capital gains. These rates are still fairly high, compared to most personal tax rates. The highest personal tax rate in Alberta in 2021 is 48%, for incomes above $314,928.

Similarly, not every business owner will be affected by the increased eligible dividend tax rate, since not every corporation is able to pay eligible dividends. For most businesses owned by Canadian residents, a corporation can only pay eligible dividends to the extent it has earned income in the past that was taxed at the regular business rate (i.e., not the small business rate) or to the extent the corporation has received eligible dividends on its investments in the past.

For businesses that are able to pay eligible dividends, business owners should expect a higher cost of withdrawing funds from their corporation after January 1, 2021. Until that date, however, the current, lower eligible dividend tax rate will continue to apply. As a result, some business owners may have an incentive to pay a larger amount of eligible dividends in 2020, in order to take advantage of the lower eligible dividend tax rate this year.

The decision of whether to pay more eligible dividends in 2020 to avoid the increased tax rate in 2021 is a personal decision, and one that will differ for each individual’s circumstances. We would recommend that business owners seek advice from their own tax advisors prior to the end of 2020, in order to confirm whether it is advisable to plan into this tax rate increase.

How are investors affected?

The eligible dividend rate is also important for investors resident in Alberta for tax purposes, regardless of whether they own their own business. Most dividends received on publicly-traded company shares or through mutual fund trusts will be “eligible” dividends. To the extent investors own public shares or mutual funds in a non-registered account, the tax rate on eligible dividends received on those investments should increase, effective January 1, 2021, by approximately 2.6%.

This tax change should generally not affect investments in a tax-advantaged registered account like a Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA).

Summary

The previously-announced reduction in the general corporate tax rate has been formalized with legislation, which is expected to pass into law. The general corporate tax rate will reduce from 10% to 8%, effective July 1, 2020. This may affect business owners that pay tax on income at rates other than the small business rate, as well as business owners with corporate investments.

Alongside the reduction in the corporate tax rate, the Alberta government introduced an increase to the eligible dividend tax rate. This tax increase will take effect January 1, 2021, and business owners may be able to plan for this change during November and December of 2020. After that date, business owners and investors with non-registered accounts should expect to pay a higher tax rate on eligible dividends.