David, age 45, is in the top marginal tax bracket in Ontario. He owns shares in a Canadian public company that pays eligible dividends. If he were to receive $1,000 in eligible dividends, which statement best describes the combined effect of the gross-up and dividend tax credit on his tax liability?

Question: David, age 45, is in the top marginal tax bracket in Ontario. He owns shares in a Canadian public company that pays eligible dividends. If he were to receive $1,000 in eligible dividends, which statement best describes the combined effect of the gross-up and dividend tax credit on his tax liability?

Answer options:

• The gross-up increases his taxable income to reflect corporate taxes paid, and the dividend tax credit then reduces his provincial tax. This can result in a significant tax reduction compared to other income. ✅ The gross-up increases his taxable income to reflect corporate taxes paid, and the dividend tax credit reduces his federal and provincial tax payable, aiming to partially integrate corporate and personal tax.
• The gross-up and dividend tax credit are designed to fully eliminate double taxation on eligible dividends, resulting in a net tax of zero for most high-income earners.
• The gross-up is an accounting adjustment with no real tax impact, while the dividend tax credit effectively lowers his marginal tax rate on the dividend income by a fixed percentage.

Correct answer: The gross-up increases his taxable income to reflect corporate taxes paid, and the dividend tax credit reduces his federal and provincial tax payable, aiming to partially integrate corporate and personal tax.

Explanation: The gross-up on eligible dividends increases the investor's taxable income to an amount that approximates the pre-tax corporate profit. The dividend tax credit then reduces the federal and provincial taxes otherwise payable, aiming to integrate, not eliminate, the corporate and personal tax burdens.