What is the difference between eligible and non-eligible dividends?

The mechanical difference between the two

Every dividend a Canadian corporation pays out is designated as either eligible or non-eligible, and the label changes how much tax you personally pay on it. Eligible dividends receive a 38% gross-up and a larger dividend tax credit; non-eligible dividends receive a 15% gross-up and a smaller credit. Both mechanisms exist for the same reason: to give you personal credit for tax the corporation already paid, so the more corporate tax that was paid on the underlying income, the bigger the personal credit needs to be to avoid taxing the same dollar twice. The gross-up mechanic exists because dividends are being taxed twice in principle, at the corporate level and again in your hands, and the credit is meant to approximate what the corporation already paid so you are not taxed twice on the same income. Grossing up the dividend before tax is calculated, then applying a credit against the tax on that grossed-up amount, is simply the bookkeeping method Parliament chose to hand back a personal credit for corporate tax paid, rather than taxing the actual cash dividend received at some blended in-between rate.

Why eligible dividends come from the general rate pool

Eligible dividends are meant to flow from income that was taxed at the general corporate rate, not the lower small business rate. A corporation tracks this in its general rate income pool (GRIP), which builds up from active business income earned above the small business deduction limit, income earned by a corporation that does not qualify for the small business deduction at all, and eligible dividends the corporation itself received from other corporations. A corporation can only designate dividends as eligible up to its GRIP balance.

Why non-eligible dividends come from small-business-rate income

Most owner-managed corporations pay dividends primarily out of income that used the small business deduction, taxed at Ontario’s lower small business rate. Because the corporation paid less tax on that income, the personal side compensates with a smaller gross-up and credit, and a correspondingly higher personal tax rate on the dividend. This is the default position for most small corporations: unless GRIP has built up from income taxed at the general rate, dividends paid out will be non-eligible.

When a corporation is new or small, almost everything it earns qualifies for the small business deduction, so almost every dividend it pays is non-eligible by default, and GRIP rarely builds up. Once active business income starts exceeding the small business limit, or the corporation earns investment income taxed at the general rate, GRIP begins to accumulate, and eligible dividends become available for the first time. A corporation that never grows past the small business limit, and never earns much investment income, may go years without a meaningful GRIP balance to draw on.

How the designation actually happens

A corporation designates a dividend as eligible in the resolution declaring it and again on the T5 slip issued to the shareholder, with written notification required at or before the time the dividend is paid. Designating more as eligible than the corporation’s GRIP balance supports triggers a special penalty tax under Part III.1 of the Income Tax Act, so this is not a box to check casually; the GRIP balance needs to be calculated first. Corporations that are not Canadian-controlled private corporations track a parallel balance called the low rate income pool (LRIP), which limits how much they can designate as eligible in the other direction.

A corporation that itself receives eligible dividends from another company, such as portfolio dividends on a stock investment or dividends from a subsidiary, generally adds those dividends to its own GRIP, which is one of the more overlooked ways a holding company builds up the ability to pay eligible dividends of its own. This is separate from the RDTOH mechanism that applies to a corporation’s own investment income, and the two balances need to be tracked side by side rather than confused with one another.

What this means for your personal tax bill

At every income level in Ontario, eligible dividends are taxed more lightly in your hands than non-eligible dividends, because the larger credit better reflects the higher corporate tax already paid on the underlying income. The exact combined federal and Ontario rates on each type shift from year to year with indexing and rate changes, so we check the current tax tables rather than quoting a prior year’s numbers, but the direction is consistent: eligible beats non-eligible, dollar for dollar, at the personal level. This is also why a corporation weighing whether to keep income inside the business or pay it out should look at the eligible or non-eligible split alongside the choice between salary and dividends, rather than treating dividend type as an afterthought decided only at the moment a T5 is prepared.

How we handle this

We calculate the GRIP balance before dividends are declared each year, so the eligible or non-eligible split is set correctly the first time rather than corrected after the fact, and we reflect the right designation on the T5 slip and in the minute book. This runs alongside our corporate tax services and our broader work on owner compensation planning.