You pay yourself a dividend from your corporation. Straightforward, right?
Except six months later, you get a CRA notice. Turns out you designated your dividend as “eligible” when your corporation didn’t have the balance to support it. Now you owe a 20% penalty on top of the tax you already paid.
This happens more often than you’d think. And it’s entirely avoidable.
Why Dividend Type Matters
When you pay yourself dividends in Canada from your corporation, you don’t just pay “a dividend.” You pay either an eligible dividend or a non-eligible dividend. The designation determines how much personal tax you’ll owe.
Here’s the quick version:
- Eligible dividends come from corporate income taxed at the general rate (roughly 23-31% depending on province)
- Non-eligible dividends come from income taxed at the small business rate (roughly 9-12.5%)
Because eligible dividends come from income that already faced higher corporate tax, you receive a larger dividend tax credit to compensate. This results in lower personal tax on eligible dividends compared to the same cash amount paid as non-eligible.
The difference isn’t trivial. On a $10,000 dividend in Ontario at the top marginal rate, eligible treatment saves you roughly $1,000 compared to non-eligible.
The GRIP Problem Most Owners Don’t Know About
Here’s where things go wrong.
Your Canadian-controlled private corporation (CCPC) tracks its ability to pay eligible dividends through something called the General Rate Income Pool—GRIP for short. This is a notional account that increases when your corporation earns income taxed at the general rate.
Most small CCPCs earn active business income under $500,000, which qualifies for the small business deduction. That income is taxed at the lower rate. It builds your LRIP (Low Rate Income Pool), not your GRIP.
The result: Many small business owners have little or no GRIP balance, which means they cannot pay eligible dividends—even though eligible treatment would save them tax personally.
If you designate a dividend as eligible when you don’t have sufficient GRIP, you trigger a Part III.1 penalty of 20% on the excessive amount. The CRA will also recharacterize the excess as non-eligible, so the recipient loses the tax benefit anyway.
How to Know Which Type You Can Pay
Before paying any dividend, answer this question: what type of corporate income is funding it?
You likely have GRIP (can pay eligible) if:
- Your corporation earns active business income above $500,000 annually
- You have investment income taxed at the general corporate rate
- Your corporation received eligible dividends from other Canadian corporations
- You have a holding company structure with passive income
You likely have only LRIP (non-eligible only) if:
- Your CCPC earns under $500,000 in active business income
- All your income qualifies for the small business deduction
- You haven’t received eligible dividends from other corporations
Most owner-managers of small CCPCs fall into the second category. Their dividends should be non-eligible.
The Mechanics: Gross-Up and Credit
The Canadian tax system uses a gross-up and credit mechanism to achieve “integration”—the idea that income should bear roughly the same total tax whether earned personally or through a corporation.
For eligible dividends:
- Gross-up: 38%
- Federal dividend tax credit: 15.02% of the grossed-up amount
For non-eligible dividends:
- Gross-up: 15%
- Federal dividend tax credit: 9.03% of the grossed-up amount
Provincial credits add to this, varying by jurisdiction.
The higher credit on eligible dividends reflects the higher corporate tax already paid. When the corporate rate is lower (small business rate), the personal credit is correspondingly smaller.
Three Mistakes I See Repeatedly
1. Assuming All Dividends Are the Same
Some business owners don’t realize there are two types. They pay themselves without designating, and the dividend defaults to non-eligible. That’s fine if non-eligible is correct—but if they had GRIP, they missed out on the lower-taxed eligible option.
2. Designating Eligible Without Checking GRIP
The opposite problem: designating as eligible because it sounds better, without confirming the corporation has sufficient GRIP. This triggers the 20% penalty.
3. Not Tracking GRIP and LRIP Annually
These balances should be calculated and documented every year as part of your corporate tax preparation. If you’re not tracking them, you’re guessing—and guessing with CRA penalties on the line isn’t a good strategy.
The T5 Slip: Getting It Right
When your corporation pays dividends, it issues a T5 slip. The boxes differ by type:
Eligible dividends:
- Box 24: Actual amount
- Box 25: Taxable amount (grossed-up)
- Box 26: Federal credit
Non-eligible dividends:
- Box 10: Actual amount
- Box 11: Taxable amount (grossed-up)
- Box 12: Federal credit
Using the wrong boxes creates problems. The CRA will reassess, and you’ll need to issue corrected slips. Document the designation in a board resolution when you declare the dividend—this creates a clear record.
What About Salary vs Dividends?
This is a separate question, but it connects. Some business owners avoid dividends entirely, paying themselves only salary to keep things simple.
Salary has advantages: it creates RRSP room, counts toward CPP benefits, and is deductible to the corporation. Dividends in Canada don’t create RRSP room and don’t contribute to CPP—but they avoid payroll taxes and can be more flexible.
The optimal mix depends on your personal situation, income level, and province. There’s no universal answer.
Getting It Right
The dividend system isn’t complicated once you understand it, but the stakes for getting it wrong are real. A 20% penalty on an incorrectly designated dividend adds up fast.
For a complete walkthrough of eligible vs non-eligible treatment—including the gross-up calculations, GRIP tracking, and T5 reporting requirements—see FShad CPA’s breakdown of eligible vs non-eligible dividends.
The bottom line: know your GRIP balance before you designate. If you’re not sure, ask your accountant. It’s a much cheaper conversation than explaining the penalty to CRA later.
AUTHOR BIO:
Faiq Shad, CPA, LPA, is the founder of FShad CPA Professional Corporation, a Woodbridge-based accounting firm specializing in corporate taxation and CRA audit representation. He helps small businesses and content creators navigate Canadian tax compliance. Learn more at shadcpa.ca
