If you pay yourself with dividends from your corporation, the T5 slip has to label each one as eligible or non-eligible (the slip calls the latter "other than eligible"). The two are taxed differently on your personal return, and eligible dividends carry a lower personal rate — which makes the eligible box look like the obvious choice.
It isn't a choice. Whether your corporation can pay an eligible dividend depends on whether it has built up a balance called the GRIP — General Rate Income Pool — from income that was taxed at the full corporate rate. Designate eligible dividends beyond that balance and you trigger a special penalty tax. The label has to match the income behind it.
- Two types, two tax treatments. Eligible dividends get a 38% gross-up and a larger dividend tax credit; non-eligible get a 15% gross-up and a smaller credit. Eligible = lower personal tax.
- The type isn't optional. You can only pay eligible dividends to the extent of your corporation's GRIP — a pool built from income taxed at the general (non-small-business) corporate rate.
- Most small CCPCs have little or no GRIP, because their income was taxed at the low small-business rate. Their dividends are normally non-eligible.
- Over-designate and you're penalized. Designating more eligible dividends than your GRIP allows triggers Part III.1 tax — 20% of the excess. The "lower-tax" box becomes a tax bill.
- The whole system exists for integration: the gross-up/credit roughly offsets the corporate tax already paid, so income isn't taxed twice. That's why the rates differ by source.
Read on for how each type is taxed, why GRIP decides it, the over-designation penalty, a real example, and how to get the designation right.
Same cash, different tax treatment
Both kinds of dividend are paid out of after-tax corporate profits, but they're "grossed up" and credited differently on your personal return to reflect how much corporate tax was already paid on the underlying income:
| Eligible dividend | Non-eligible (other than eligible) | |
|---|---|---|
| Comes from corporate income taxed at… | the general rate (no small-business deduction) | the small-business rate |
| Gross-up | 38% | 15% |
| Federal dividend tax credit | larger (6/11 of the gross-up) | smaller (9/13 of the gross-up) |
| Personal tax in your hands | lower | higher |
| You can pay it only if you have… | GRIP | (generally available to a CCPC) |
So yes — at the personal level, eligible dividends are the cheaper way to receive money. That's exactly why the system gates them behind GRIP.
Source: Income Tax Act, s. 121 (dividend tax credit) and s. 82 (gross-up); CRA, Eligible dividends.
GRIP decides what you can designate
The reason eligible dividends are taxed gently is that the underlying corporate income already paid the high corporate rate. The CRA tracks how much such income a corporation has earned in the General Rate Income Pool (GRIP). A CCPC can pay eligible dividends only up to its GRIP balance at year-end — and to pay one, it must formally designate it as eligible (in writing to the shareholder, at or before the time it's paid).
This is the crux: a small business whose income was all sheltered by the small-business deduction was taxed at the low rate, so it has little or no GRIP — and therefore little or no room to pay eligible dividends. Its dividends are properly non-eligible, taxed a bit higher personally, because the corporate side paid less. Ticking "eligible" doesn't change that reality; it just mislabels it.
Source: CRA, General rate income pool (GRIP); Income Tax Act, s. 89(1) (GRIP and "eligible dividend") and s. 89(14) (designation).
Over-designate, and Part III.1 tax shows up
This is what makes the wrong box expensive rather than merely incorrect. If a corporation designates more eligible dividends than its GRIP supports — an "excessive eligible dividend designation" — it's hit with Part III.1 tax of 20% on the excess (higher in cases the CRA considers deliberate). The shareholder got a slightly lower personal rate; the corporation gets a 20% penalty that wipes that out many times over.
It's the opposite of a loophole. The eligible box looks like the taxpayer-friendly option, but using it without the GRIP to back it is one of the cleaner ways for a small corporation to manufacture a penalty out of nothing.
Source: Income Tax Act, s. 89(1) ("excessive eligible dividend designation"); Part III.1 tax (s. 185.1). See also CRA, Eligible dividends.
The consultant who ticked the wrong box
Meet Robert, who runs Stratus Consulting Inc., a management-consulting CCPC in Oakville, Ontario. The corporation earns about $400,000 a year of active business income — all of it under the $500,000 small-business limit, so all of it taxed at the low small-business rate. That means Stratus has essentially no GRIP.
Robert pays himself a mix of salary and $80,000 of dividends. When the T5 is prepared, he (reasonably, but wrongly) reasons that "eligible dividends are taxed less," and the dividends get designated as eligible — the lower-personal-tax box. On his personal return it saves him a few thousand dollars versus non-eligible. Job done, he thinks.
Except Stratus had no GRIP to support an eligible designation. The entire $80,000 is an excessive eligible dividend designation, and Part III.1 tax of 20% applies:
Illustrative. The personal saving is small; the corporate penalty is not. The dividends should simply have been designated non-eligible.
The eligible box isn't the "save money" box. It's the "I have GRIP to back this up" box — and Stratus didn't.
Had the dividends been correctly designated non-eligible, Robert would have paid slightly more personal tax and that would have been the end of it — properly integrated with the low corporate rate Stratus already paid. The error wasn't paying dividends; it was claiming a status the corporation hadn't earned.
What should have happened
- Check the GRIP balance before designating anything eligible — no GRIP, no eligible dividends.
- For a CCPC living on the small-business rate, expect dividends to be non-eligible by default.
- Only designate eligible up to GRIP, and make the designation properly (in writing, at/before payment).
- Match the T5 box to the corporate reality — it's a reporting of fact, not a tax-planning lever.
A quick dividend checklist
- Do you know your corporation's GRIP balance for the year?
- Is each dividend's eligible/non-eligible designation backed by that balance?
- If you earned income above the small-business limit (which builds GRIP), are you actually using your eligible-dividend room?
- Are designations made in writing at or before payment, and reported correctly on the T5?
- Has anyone checked for an excessive eligible designation before filing?
Getting dividend designations right — and noticing when you do have GRIP worth using — is exactly the kind of detail that separates a tidy file from a penalty. It's part of what's included in every CDL plan, and you can estimate the cost in about a minute.
The label has to match the income
Eligible dividends really are taxed more kindly — but only because the income behind them already paid full corporate tax, tracked in your GRIP. For most small CCPCs, the honest answer is non-eligible, and trying to upgrade that with a checkbox doesn't save tax; it manufactures a 20% penalty. Know your GRIP, designate to match, and the dividend system does what it's designed to do: tax the income once, at the right level.
Not sure your dividends are designated correctly?
Eligible vs. non-eligible isn't a preference — and getting it wrong is a 20% penalty, not a saving. A 20-minute call is enough to check your GRIP and your T5s.
Book a Free 20-Minute CallThis article is for informational purposes only and does not constitute tax advice. Dividend taxation, GRIP, designations, and penalty rules are detailed and change over time, and the figures above are illustrative. Consult a qualified professional before paying or designating dividends.
Primary sources, linked so you can read and interpret them yourself. Legislative links open on the official Justice Laws website; agency links open on the Government of Canada website.
- Income Tax Act, s. 89 — definitions of "eligible dividend," GRIP, and the eligible-dividend designation (89(14)), Justice Laws
- Income Tax Act, s. 121 — the dividend tax credit
- CRA — Eligible dividends
- CRA — General rate income pool (GRIP)
- Related reading: Salary vs. Dividend, Income Splitting After TOSI, and The Capital Dividend Account (the tax-free dividend).