Provincial budgets could pay off in dividends

Investors in Alberta, Quebec and Ontario will want to pay close attention to budgets in those provinces due out this week if they’re banking on the federal government’s promise to eliminate the double taxation of dividends.

Starting Wednesday, investors will get their first indication whether the three provinces are going to follow Ottawa’s lead announced last November, when it slashed the rate of taxation on dividend income. Alberta will be first up with its budget tomorrow followed by Ontario and Quebec on Thursday.

Even if the provinces stay mum on dividends, investors should check the fine print. As Don Drummond, TD’s chief economist, has been pointing out since the federal government’s surprise announcement in the fall, the provinces have to raise their dividend tax credit rates or else their taxation of dividend income will go up $2.06 on a $100 of dividend income. This would happen, he explains in a special report, because the higher gross up factor would raise normal provincial personal income tax collections $3.40, but only raise the provincial dividend tax credit $1.34.

“In other words,” Drummond continues, “the average provincial dividend tax credit rate has to increase form 6.667% to 8.727%, merely to leave provincial taxation of dividend income unchanged.”

The federal Conservatives have already indicated that they plan to follow through on their predecessor’s proposal to level the playing field between dividend-paying stocks — possibly in its first budget expected sometime in April — and trusts, but the provinces are under no obligation to do so. The proposal calls for an increase in the dividend gross-up from 125% to 145% and a rise in the federal dividend tax credit from 13.333% to 19% for dividends subject to the general corporate income tax rate.

So far, British Columbia and Manitoba have indicated that they will be raising their dividend tax credits, however they’ve been short on detail — perhaps not surprising considering the legislation still has to be tabled by the federal government. Drummond thinks Ontario, Quebec and Alberta will likely follow suit.

“The only reason I thought I thought we might not see anything in this budget round is just because we don’t have the details on the legislation from the federal government, but I thought B.C. and Manitoba handled that rather cleverly,” Drummond says. He hopes the other provinces follow that model.

Drummond says the cost of this tax measure would be greatest to Ontario, which takes a disproportionate share of the dividend revenue. The credit is worth about $150 million to Queen’s Park or about half of what Ottawa collected from the credit. B.C. stated in its budget the change to the tax credit there will cost them about $25 million.

Several provinces might be tempted to hold firm on any changes to their dividend tax credit to get a handle on their budget shortfall. According to a recent provincial forecast by Scotiabank’s Global Economic Research division, Ontario will slip further into deficit this year while Manitoba, Saskatchewan, B.C., New Brunswick and Nova Scotia will see their surpluses shrink. Still, Drummond says that’s not likely to happen. Provinces like Ontario need to do this because they are at risk of losing the corporate tax base in a conversion to income trusts, he says.

The budget season continues next week in New Brunswick and Newfoundland and Labrador.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(03/21/06)