Eligible vs Ineligible Dividends: What's the Difference in Canada?

Paying yourself a dividend instead of a salary is a choice many Canadian-controlled private corporation owners make. What many don't realize is that the eligible vs ineligible dividend distinction has a real tax impact on what they pay personally. The category depends on how your corporation was taxed, and it changes what you pay in personal tax through the applicable gross-up and the resulting dividend tax credit.

This isn't a theoretical nuance. On the same $1,000 dividend, the gap can exceed $100 in net federal tax. Over an annual compensation package, that adds up quickly.

Our tax specialists break down the difference between an eligible and an ineligible dividend, what it means for your tax return, the applicable gross-up, and why the dividend designation must be made correctly from the start.

What is an eligible dividend?

An eligible dividend, also called a qualifying dividend, is paid out of profits your corporation taxed at the general corporate tax rate — not the reduced small business rate. On your personal tax return, it is grossed up by 38% and qualifies for a more generous federal dividend tax credit, resulting in lower net tax payable than an ineligible dividend.

This applies when your corporation does not benefit from the Small Business Deduction, or when its active business income exceeds the SBD limit of $500,000 federally.

General Rate Income Pool (GRIP) limits what you can designate

When your corporation earns income taxed at the general corporate rate, that income is tracked in a notional account called the General Rate Income Pool, or GRIP. The balance in this account sets the ceiling on how much your corporation can designate as eligible dividends in a given year.

If your GRIP balance is zero, you cannot legally designate a dividend as eligible. It must be paid as ineligible — a situation common for CCPCs whose income has consistently fallen within the SBD limit and has not included income taxed at the general rate.

How to designate an eligible dividend

To designate a dividend as eligible, your corporation must notify shareholders in writing at or before the time of payment, under subsection 89(14) of the Income Tax Act (ITA). Acceptable methods include a written letter to shareholders, a notation on the dividend cheque stub, or a director's resolution where all shareholders are also directors.

That designation must be reflected on the T5 slip issued to each shareholder: Box 24 for eligible dividends, Box 10 for non-eligible dividends.

What is an ineligible dividend?

An ineligible dividend, also called an ordinary dividend in everyday language, is paid out of profits taxed at the reduced corporate rate. This is the case for CCPCs that benefited from the Small Business Deduction on their active income: the SBD at the federal level or the provincial deduction in Quebec.

Because the corporation paid less tax at source, the applicable gross-up is only 15%. The resulting dividend tax credit is therefore less generous, and you pay more personal tax than with an eligible dividend, even if the amount received is identical.

This is the type of dividend the vast majority of Canadian CCPCs pay.

Misclassification carries real consequences

Incorrectly designating a non-eligible dividend as eligible triggers Part III.1 tax under the Income Tax Act. The standard penalty is 20% of the excessive eligible dividend designation. In cases where the CRA determines the designation was part of a tax avoidance scheme, that rate increases to 30% of the full designation amount.

Corrective options exist but are limited and subject to strict conditions. The safest approach is to verify your GRIP balance before any eligible dividend designation.

How are eligible and ineligible dividends taxed?

The tax treatment of a dividend relies on two interconnected mechanisms: the gross-up, which increases your taxable amount, and the dividend tax credit, which then reduces your final bill. Understanding both is essential to accurately calculating your corporate and personal taxes.

The dividend gross-up

The gross-up is a technical adjustment that reconstitutes the amount the dividend represented before corporate tax was applied. Your personal tax is calculated on this adjusted amount, before the credit reduces the final bill.

The gross-up rate depends on the type of dividend: 38% for eligible dividends, and 15% for ineligible dividends. This rate is directly tied to your corporation's tax rate, which varies by province:

• Corporate tax rates in Quebec
• Corporate tax rates in Ontario
• Corporate tax rates in British Columbia

The non-refundable dividend tax credit

Once the gross-up is added to your taxable income, a non-refundable dividend tax credit reduces the bill. This credit applies at two levels: federal and provincial.

At the federal level, the 2025 rates are fixed: 15.0198% of the grossed-up amount for eligible dividends, and 9.0301% for ineligible dividends. At the provincial level, rates vary by province. In Ontario, for example, the rate is 10.00% for eligible dividends and 2.99% for ineligible dividends, applied to the grossed-up amount. The provincial dividend tax credit stacks on top of the federal credit and further reduces the tax payable.

It is the combination of the gross-up and the dividend tax credit that determines what you actually pay.

Eligible vs ineligible dividends: sample tax calculation

To illustrate the real tax difference between the two dividend types, here is a side-by-side example based on a $1,000 dividend, using a 30% personal marginal tax rate (provincial credit excluded).

For the same $1,000 dividend, the eligible dividend generates $207 in net federal tax, versus $241 for the ineligible dividend. The gap may seem modest on a single payment, but it compounds quickly over an annual compensation package. And that is before the provincial credit, which reduces the actual tax further depending on your province.

The role of the RDTOH in corporate tax planning

When your corporation holds investments such as interest, portfolio dividends, or capital gains, it pays a higher tax rate on this type of income than on its operating income. To avoid double taxation, a portion of this tax is set aside in a notional account: the Refundable Dividend Tax on Hand, or RDTOH. This amount becomes refundable to your corporation as soon as it pays a taxable dividend.

The refund rate depends on the type of dividend paid and the corresponding RDTOH account:

• Eligible dividend: 38.33% of the eligible RDTOH is refunded
• Ineligible dividend: 30.67% of the non-eligible RDTOH is refunded

For example, if your corporation has accumulated $10,000 in eligible RDTOH and pays eligible dividends, it can recover up to $3,833.

If your CCPC generates investment income, paying out dividends is not just a compensation decision. It is also a tool to recover the tax held in reserve.

Make the most of your dividend strategy with T2inc.ca

Eligible or ineligible, neither is systematically better than the other. The right choice depends on your corporation's tax situation, your personal income, your province of residence, and in some cases it is simply dictated by the nature of the profits being distributed.

What makes a real difference is an upfront tax optimization strategy that acts on your corporation's tax structure and reduces the overall tax burden for you as the owner. Our tax specialists offer tax consultations to analyze your situation and identify the levers available to you.

This article is for informational purposes only and does not constitute tax advice. Every situation is different. We recommend consulting a qualified CPA for your specific case.

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