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Provinces may be spoilers of change on dividend taxes

Ottawa's needs them to be in lockstep by offering an increase in their credit levels

Many Canadian investors are breathing a sigh of relief today given Wednesday's news that Finance Minister Ralph Goodale has spared income trusts from the fate of the dodo bird. Make no mistake, cutting the tax burden on eligible dividends from public corporations can only be a good thing for your pocket book.

I do have one problem, however, with the announcement made by Mr. Goodale this week. And it's no small matter. You see, Ottawa has assumed that the provinces and territories will also step up to the plate and offer tax relief on the same eligible dividends. Now, if you read through the Department of Finance news release, it's clear that Ottawa does expect the provinces to pony up -- and pony up big time.

For example, the dividend tax credit (DTC) offered by the federal government prior to the change this week was 13.3 per cent of the grossed-up dividend. Add to that the average provincial DTC of 6.2 per cent, for a total DTC of 19.5 per cent of the grossed-up dividend. Following the change this week, the federal government is now offering a 19-per-cent DTC, but forecasts in its calculations a total DTC of 32 per cent. Ottawa is assuming, then, that the provinces will increase their average DTC to 13 per cent.

So, do the math. The average provincial DTC is 6.2 per cent today, but Ottawa is expecting it to jump to 13 per cent in order to accomplish what it had hoped when making its proposal this week -- to achieve a level playing field between corporate shares and income trusts. That is, Ottawa expects the provinces to more than double the tax relief they currently offer on eligible dividends. Good luck with that.

Consider, for example, the province of New Brunswick and territory of Nunavut. Both jurisdictions have actually reduced the amount of their DTC in the past three years. Do you think they'll be quick to do an about-face and more than double the DTC today? Don't hold your breath.

The bottom line? The amount of tax relief you receive from the proposal Mr. Goodale announced this week depends significantly on how generous your province is feeling. And what if your province decides to act more like Scrooge than Santa on this issue?

Well, consider a tale of two cities: Toronto and Vancouver. Suppose an investor in the highest tax bracket lives in Toronto and earns $10,000 of eligible dividend income in 2006. Assume also that Ontario decides to offer the 13-per-cent DTC that Ottawa is hoping for. The investor will save $2,964 in taxes as a result of the combined federal-provincial DTC. Now consider an identical investor in Vancouver. And let's assume British Columbia chooses not to offer any type of increase to its DTC. That investor will save just $2,232 as a result of the combined federal-provincial DTC. The B.C. resident receives almost 25 per cent less in tax relief from the DTC than our Ontario investor in this example.

So, before you get too excited about any newfound wealth you might experience from the proposal announced this week, wait to hear from your provincial government. With growing inequality in taxation between provinces, one has to wonder when the entire Canadian population will get up and relocate to one place in the country or another.

How cold does it get in Nunavut in January anyway?

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

© The Globe and Mail

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