Updated: Apr 25, 2021
The thing you need to know about dividend taxation in Canada is what's called the dividend gross-up. It involves two steps.
1) Dividends received are "grossed up" by some amount. The idea being that the grossed-up amount represents the income the corporation paying the dividend had before it was taxed.
2) A tax credit is given to the individual to compensate for the amount that has already been paid by the corporation paying the dividend.
A corporation earns $100 before tax and has to pay $10 tax. After-tax earnings are therefore $90.
You own all shares and receive a $90 dividend. The dividend is grossed up by 11.11%. The grossed-up amount is ~$100.
You are charged tax on the grossed-up amount. If your tax rate is 50% then you would pay $50 tax less a credit of $10 (gross-up amount).
The after-tax divined received is $90 - $50+ $10 or $50. Notice that this is the same as paying the 50% rate on the corporation's before-tax earnings.
In the real world, custom gross-up rates are not made every time. Instead, its simplified into two types of dividends.
1) Eligible - most public companies in Canada
2) Non-eligible - most Candian Controlled Private Corporations
This makes sense because Candian Controlled Private Corporations pay a lower corporate tax rate. Candian public companies will tell you if the dividend is eligible. A relevant news release can be found on SEDAR if you are curious.
After you have grossed up the dividend amount the credit that is given will be partially applied to your Federal Taxes and partially applied to your provincial taxes.
A dividend of $100 grossed up by 1.38 has the grossed-up amount of $138.
The federal credit is (6/11)*$38
Provincial credit is (5/11)*$38
Withholding tax on U.S Investments
For Canadians receiving dividends from US companies, there is a 15% withholding tax applied. Also, they don't apply for the preferential tax treatment shown above. Instead, investors receive a foreign tax credit.
What is even more important to know is if you own shares of a US company in your RRSP or RRIF you will not pay any withholding tax. This a result of a tax treaty. It also means you won't receive a foreign tax credit.
The TFSA does not shelter you from withholding tax, nor will you get a foreign tax credit.
As a result, it is most tax-efficient to hold US dividend-paying companies in an RRSP.