A dividend is a distribution of a company's profits to its shareholders. It represents a share of the earnings and is typically paid in cash, though it can also be paid in stock or other property. In Canada, dividends from Canadian corporations receive special tax treatment through the dividend tax credit, making them a significant component of investment income for many individuals. Understanding how dividends work, their tax implications, and the rules governing their payment is essential for Canadian investors and business owners.
What Is a Dividend?
A dividend is a payment made by a corporation to its shareholders out of its profits or retained earnings. It is a method of distributing a portion of the company's success to its owners. The payment is allocated as a fixed amount per share, meaning shareholders receive dividends in proportion to their ownership stake. For example, if a company declares a cash dividend of 50 cents per share, an investor owning 100 shares would receive $50. Dividends are not considered a business expense but rather a division of after-tax profits. They do not appear on a company's income statement but are reflected as a reduction of retained earnings on the balance sheet. The word dividend originates from the Latin word 'dividendum', meaning 'thing to be divided'. Public companies usually pay on a fixed schedule, but can cancel a scheduled dividend or declare a special one-time dividend at any time.
Historical Development and Legal Framework
The practice of paying dividends has a long history in corporate finance. The Dutch East India Company, established in 1602, is recognized as the first public company to pay regular dividends, distributing annual dividends worth around 18 percent of its share value for nearly two centuries until 1800. In common law jurisdictions, courts have historically given company directors wide discretion over dividend policy. A key Canadian case establishing this principle of non-interference was Burland v Earle in 1902, a precedent mirrored in British and Australian cases from the same era. However, legal perspectives can evolve, as seen in a 2013 Australian case where the Supreme Court of New South Wales broke with precedent and recognised a shareholder's contractual right to a dividend. In Canada, the rules governing corporate distributions are designed to protect shareholders and company viability, ensuring dividends are paid from genuine profits and not from capital.
In the United Kingdom, the rules for dividend payments are governed by Part 23 of the Companies Act 2006. This act states that a company can only make a distribution out of its accumulated, realised profits, less its accumulated, realised losses. Following a consultation on insolvency and corporate governance in 2018, the UK government considered reviewing the existing rules on dividend distribution. The proposed aim was to address concerns where companies in financial distress were still able to distribute significant dividends to their shareholders. One proposed requirement was for the largest companies to publish a distribution policy statement covering dividend distribution. Furthermore, the law in England and Wales regarding dividend payment was clarified in 2018 by the Court of Appeal in the case of Global Corporate Ltd v Hale. In that case, the court ruled that payments treated as dividends from an anticipated profit could not be later recharacterised as payments for services once the company entered liquidation.
Forms of Dividend Payments
Corporations can distribute dividends to shareholders in several forms, each with different characteristics and implications. Cash dividends are the most common form, paid out in currency via electronic transfer or cheque. They are treated as investment income in the year they are paid, not necessarily the year declared. Stock or scrip dividends are paid out as additional shares of the issuing corporation. For instance, a 5% stock dividend gives shareholders 5 extra shares for every 100 owned. This does not change the total market value or market capitalization of the shareholder's holding because the share price adjusts downward, and there is no negative dilution as shares are issued at the pre-existing market price. Property dividends, or dividends in specie, are paid out in the form of assets, such as securities of other companies, products, or services. These are relatively rare and are recorded at market value when paid.
Special dividends are a one-time, non-recurring payment made in addition to or instead of regular dividends, often from a surplus or unusual profit. Interim dividends are payments made before a company's annual general meeting and final financial statements, often accompanying interim financial results. Preferred shares have a priority claim on dividends. A company must pay dividends to preferred shareholders before any distributions can be made to common shareholders. In structured finance, dividends can also take the form of financial assets with known market value, such as warrants, or shares in a subsidiary company as part of a corporate spinoff.
Dividend Dates and Their Sequence
The process of declaring and paying a dividend follows a specific timeline with several key dates that determine eligibility and payment. The declaration date is when the board of directors announces the dividend, creating a liability on the company's books. The in-dividend date is the last trading day before the ex-dividend date where shares are traded 'cum dividend', meaning the buyer is entitled to the upcoming dividend. The ex-dividend date is crucial for investors. It is typically one trading day before the record date. Shares bought on or after the ex-dividend date do not come with the right to receive the declared dividend, while sellers on or after that date retain the right. The record date is when the company determines which shareholders, as registered in its books, are entitled to the payment. Finally, the payment date is when dividends are mailed or deposited into shareholder accounts. The sequence of these dates is critical for investors to understand in order to receive a dividend payment.
- Declaration Date: The board announces the dividend, creating a company liability.
- In-Dividend Date: The last day to buy shares and still receive the declared dividend.
- Ex-Dividend Date: Shares trade without the right to the upcoming dividend.
- Record Date: The date on which shareholder eligibility is determined from company records.
- Payment Date: The day dividends are distributed to eligible shareholders.
Dividend Analysis, Frequency, and Reinvestment
Investors and analysts use several metrics to evaluate dividend-paying companies. The dividend payout ratio is a key measure, calculated as dividends per share divided by earnings per share. A ratio above 100% indicates a company paid more in dividends than it earned, which may not be sustainable. Another measure is the free cash flow payout ratio, which compares dividends to the company's free cash flow (operating cash flow minus capital expenditures), offering a view of the cash available for distribution. A free cash flow payout ratio greater than 100% means the company paid out more cash in dividends than the free cash it generated. Dividend frequency varies by country and company. In the US, quarterly payments are common, while they are semi-annual in Japan, the UK, and Australia, and annual in Germany. In Canada, quarterly dividends are a typical schedule for many public companies.
Dividend reinvestment plans (DRIPs) allow shareholders to automatically use their cash dividends to purchase more shares of the company, often with no commission and sometimes at a slight discount. This leverages the power of compounding and dollar-cost averaging, as reinvested dividends buy more shares when prices are low and fewer when high, and the new fractional shares themselves earn future dividends. In some cases, shareholders might not need to pay taxes on these re-invested dividends immediately, but in most cases they do. Some investment funds, like certain RBC series, are designed for investors wishing to draw regular tax-efficient income from non-registered investments and aim to pay consistent monthly distributions.
Dividends in the Canadian Investment Context
Dividends play a prominent role in the Canadian investment landscape. Many large, established Canadian companies pay dividends, often on a quarterly schedule. The S&P/TSX Canadian Dividend Aristocrats Index is designed to track companies included in the S&P Canada BMI that have increased their dividends for at least five consecutive years. Investment products like the Vanguard FTSE Canadian High Dividend Yield Index ETF seek to track the performance of the FTSE Canada High Dividend Yield Index, which measures common stocks of Canadian companies characterized by high dividend yield. Other funds, such as the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF, replicate that specific index. Canadian investors often seek dividend income for its potential to provide relatively stable cash flow, especially in retirement, and some aim to live off dividends, as companies with established track records are less likely to cut payments during market downturns.
The management and structure of dividend-paying investments involve specific details. For example, Vanguard ETFs trade at market price, not net asset value (NAV), and investors buy or sell them in the secondary market through a brokerage, potentially incurring commissions. The management expense ratio (MER) for such funds is expressed as an annualized percentage of the daily average net asset value. Distributions from funds are characterized into income types like dividends, capital gains, or return of capital at year-end. Return of capital represents a distribution amount that is paid back to investors' principal and is reported annually. The following table outlines common Canadian dividend-focused investment vehicles and their objectives.
| Investment Fund/Index | Primary Objective |
|---|---|
| S&P/TSX Canadian Dividend Aristocrats Index | Measure performance of companies with 5+ years of dividend growth |
| Vanguard FTSE Canadian High Dividend Yield Index ETF | Track the FTSE Canada High Dividend Yield Index |
| iShares S&P/TSX Canadian Dividend Aristocrats Index ETF | Replicate the S&P/TSX Canadian Dividend Aristocrats Index |
| RBC Canadian Dividend Fund (Series T/FT) | Invest in established Canadian companies for tax-efficient income |
Taxation of Dividends in Canada
Dividend income is taxable in Canada, but the system is designed to account for the fact that corporate profits have already been taxed at the corporate level. Dividends received by a Canadian resident from a Canadian corporation are subject to a gross-up and credit mechanism. There are two primary types of taxable dividends. Eligible dividends are paid by public corporations and certain private corporations out of income taxed at the general corporate rate. They are designated by the corporation and benefit from a higher dividend tax credit. Non-eligible dividends are typically paid by small private corporations out of income taxed at the lower small business rate. They receive a smaller dividend tax credit.
The dividend tax credit reduces the personal income tax payable on dividend income, resulting in a lower effective tax rate compared to ordinary income. Dividends held in registered accounts like RRSPs or TFSAs are treated differently. Within an RRSP, taxes are deferred until withdrawal. Within a TFSA, all investment income, including dividends, is entirely tax-free. Dividends from foreign corporations, such as U.S. stocks, do not qualify for the Canadian dividend tax credit and are typically subject to a foreign withholding tax, such as the 15% U.S. withholding tax, and are taxed at the recipient's highest marginal rate in Canada.
- Eligible Dividends: From income taxed at general corporate rate. Higher tax credit.
- Non-eligible Dividends: Typically from small business income. Lower tax credit.
- TFSA Dividends: All investment income, including dividends, is tax-free.
- RRSP Dividends: Tax is deferred until funds are withdrawn from the account.
- Foreign Dividends: Subject to withholding tax and taxed at marginal rate. No Canadian credit.
Dividends as Corporate Remuneration and Associated Risks
From a corporate perspective, dividends are a way for business owners, such as physicians with incorporated medical professional corporations, to pay themselves. This can offer tax advantages compared to drawing a salary, including lower personal tax rates and simplicity, as there is no need to set up payroll or make Canada Pension Plan (CPP) contributions. Income-splitting potential exists if a spouse who works in the business becomes a shareholder and receives dividends, reducing the overall household tax rate. Paying dividends also allows owners to focus on investing profits inside the corporation to build corporate assets, as keeping the personal tax rate low preserves more capital for reinvestment.
However, this strategy has significant disadvantages and complications. Unlike salary, dividends do not generate RRSP contribution room, limiting retirement savings options. Dividend payments do not entitle the recipient to future CPP benefits, placing the full onus of retirement saving on the individual. While the business avoids CPP contributions, this is a trade-off against future government pension income. Dividends are not a deductible expense for the corporation, unlike salary, which can increase the corporate tax burden if business earnings are high. Furthermore, building significant corporate investment (passive) income can limit access to the small business tax rate. The small business deduction is reduced by $5 for every $1 of passive income over $50,000 and is eliminated entirely once passive income reaches $150,000 in a year. Finally, dividends are not guaranteed. A board can reduce or eliminate them if the company's performance declines or cash is needed elsewhere, which is a key risk for investors relying on dividend income.
Frequently asked questions
What does dividend mean?
A dividend is a payment a corporation makes to its shareholders from its profits or retained earnings. It is a way for companies to share their financial success with the people who own its stock. The payment is typically a fixed amount per share, so the total a shareholder receives depends on how many shares they own. Dividends are most commonly paid in cash but can also be paid in additional stock or other property.
How are dividends paid in Canada?
In Canada, dividends are most often paid in cash, deposited electronically or sent by cheque. Many Canadian public companies pay dividends on a quarterly schedule. The payment process involves several dates: a declaration date by the board, an ex-dividend date that determines eligibility, a record date, and finally the payment date. Canadian investors can also participate in Dividend Reinvestment Plans (DRIPs) to automatically use their cash dividends to buy more shares.
How are dividends taxed in Canada?
Dividends received from Canadian corporations are taxed using a gross-up and credit system to account for corporate taxes already paid. Eligible dividends, from income taxed at the general corporate rate, receive a higher dividend tax credit than non-eligible dividends, typically from small business income. This results in a lower personal tax rate on dividend income compared to salary. Dividends earned within a TFSA are tax-free, and within an RRSP, taxes are deferred until withdrawal.
What is an eligible dividend?
An eligible dividend is any taxable dividend paid to a resident of Canada by a Canadian corporation that is designated by that corporation. These dividends are paid from the corporation's income that was taxed at the higher general corporate tax rate. In Canada, the tax treatment of dividend income varies considerably, and eligible dividends qualify for an enhanced dividend tax credit for the shareholder. This system aims to reduce the double taxation of corporate profits, as the corporation itself does not receive a tax deduction for the dividends it pays. The primary tax liability rests with the shareholder, who includes the dividend as income.
What are Canadian Dividend Aristocrats?
Canadian Dividend Aristocrats are companies tracked by indices like the S&P/TSX Canadian Dividend Aristocrats Index, which measures the performance of Canadian companies that have increased their dividends for a minimum number of consecutive years. These companies represent a portion of the market focused on consistent dividend distribution. Dividends are allocated as a fixed amount per share, with shareholders receiving income proportional to their shareholding. While such dividends can provide stable income and raise shareholder morale, they are not guaranteed to continue, as a company's board of directors has wide discretion over dividend policy and may cancel scheduled payments.
Can a company stop paying dividends?
Yes, a company can stop paying dividends. A dividend must be declared by a company's board of directors, and they have the discretion to cancel a scheduled dividend at any time. In common law jurisdictions, courts have typically given directors wide discretion regarding dividend payments, as established in cases like the Canadian precedent Burland v Earle (1902). Dividends are not an expense or a guaranteed obligation. They are a division of after-tax profits. Companies may suspend dividends to reinvest profits as retained earnings in the business or due to financial distress, preserving cash for operations instead of distribution to shareholders.
Sources and further reading
- Dividend (Wikipedia) en.wikipedia.org
- RBC Canadian Dividend Fund, RBF266 rbcgam.com
- FTSE Canadian High Dividend Yield Index ETF vanguard.ca
- What Are Dividends & How Do They Work in Canada wealthsimple.com
- How Dividends Are Taxed In Canada, Invested MD invested.mdm.ca
This article explains how things work and is not financial, tax or legal advice. Rules, limits and rates change, so check the current figures with the Canada Revenue Agency, your province or your financial institution before you act.