Is dividend from another company taxable?

TL;DR
ITA s.112 says no, s.186 says it depends.

Under s.112 ITA, when a company receives dividends from other companies, if these dividends come from a taxable Canadian corporation or a corporation resident in Canada, the amount equivalent to the dividends may be deducted from the company’s income for that year. Since it is not considered income, there is no need to pay tax on it.

The Canadian tax law is set up in this way to avoid double taxation on corporate income. This also explains why, even if the two companies mentioned here are not “connected companies”, the company that receives the dividends can still deduct this portion of the dividends from its taxable income.

Sounds pretty good, eh?

But in fact, the wording in the tax law is “may”, so there are also cases where it “may not”. So, which dividend income cannot be deducted from a company’s taxable income? The ITA provides a list in complicated language, for example, when the company receives dividends from “term preferred shares” from a financial institution, the dividends cannot be deducted.

Although s.112 stipulates that a company’s dividend income can be excluded from income (and thus tax-exempt), s.186 adds a Part IV Tax, which is roughly calculated as follows:

If the dividend is received from a non-connected company (owning less than 10% of the common/voting shares of that company), the Part IV tax is 38.33% of the total dividend
- This 38.33% seems familiar, right? Yes, it’s the tax rate for the RDTOH rebate. In other words, the company pays tax on the dividends received, and then when it pays dividends to its shareholders, it can get a full refund of the 38.33% it paid in taxes.
If the dividend is received from an affiliated/connected company (owning 10% or more of the voting stock), there are now two possibilities:
1. If the upstream company issuing the dividends does not claim a refund for the tax they paid on their dividends, then the company receiving the dividends does not have to pay tax.
2. If the upstream company issuing the dividends has claimed a refund for the tax they paid on their dividends, then the Part IV Tax payable by the company receiving the dividends is calculated as follows:
  - It equals the percentage of common shares the dividend-receiving company has in the dividend-paying company multiples the refund the paying company received on its dividends
    - And then this Part IV Tax can also be refunded when dividends are paid out to shareholders later

s.186(4) provided:

if company A holds 10% or less common/voting shares of company B, they are not connected.
If company A holds more than 10% common/voting shares of company B, they are connected.

Let’s look at an example to better understand this Part IV Tax. “Ontario Company” is a CCPC that, before the end of the fiscal year 2023, received the following amounts of dividends:

Dividends from various market investments: $14,000
Dividends received from Algonquin Company: $41,500
- Ontario Company owns 100% of the voting shares of Alqonquin Company
- Algonquin Company did not receive any dividend refund on the dividends it paid out
Dividends received from Niagara Company: $18,000
- Ontario Company owns 30% of the voting shares of Niagara Company
- Meanwhile, Niagara Company received a $15,000 dividend refund due to a payout of $60,000 in dividends.

So, how much Part IV Tax does Ontario Company have to pay due to receiving these dividends? The calculation is as follows:

Tax payable on dividend income from market investments = $14,000 x 38.33% = $5,367
Tax payable on dividends received from Algonquin Company: Since Alqonquin Company did not refund taxes, Ontario Company does not have to pay any Part IV tax
Tax payable on dividends received from Niagara Company = Dividend refund received by Niagara Company $15,000 x Ontario Company’s shareholding percentage in Niagara Company 30% = $4,500

In general, Part IV tax is indeed a tax on corporations, but this tax can also be refunded later, which is why it is called a refundable tax.