Changes to dividend deduction could impact financial products: report

The federal government is moving ahead with changes to the tax treatment of dividends on Canadian shares for financial institutions, a move that could filter down into higher fees for investment products.

The “dividend received deduction” allows corporations to claim a deduction on dividends received from shares of Canadian corporations, effectively excluding the dividends from income.

However, in the 2023 budget, the government said the deduction conflicts with rules that require gains on mark-to-market property to be included in ordinary income. As a result, beginning Jan. 1, 2024, the government is denying the dividend received deduction for dividends received by financial institutions on shares that are mark-to-market property.

In a report released Tuesday, TD Securities said eliminating the dividend deduction is likely to impact certain financial products.

“Your friendly Canadian dealer just got its taxes raised, and the elimination of some of the previous tax deductions will likely flow through to some of the financial products they offer,” the report said.

TD said desks that are long Canadian equities as a hedge or to offset exposure will be affected. “Many financial products in Canada have a Canadian equity as an underlier,” it said. “The tax changes are likely to impact the pricing on some of these financial products.”

When it comes to ETFs, the report said the impact would differ depending on the types of transactions firms use, noting that most dealers keep low inventories of ETFs and stocks.

“One thing is for certain, the withdrawal from the elimination of the dividend prescription will be felt not only by the banks and their capital markets divisions but also institutional and retail investors,” the report said.

In its fall economic statement last week, the Liberal government carved out an exception to the new measure for “taxable preferred shares.”

The 2023 budget estimated the elimination of the dividend received deduction would bring in $3.15 billion over five years starting in 2024. The economic statement estimated the exception would reduce that amount by $215 million.

The measure was included in a Notice of Ways and Means Motion tabled Tuesday in the House of Commons to introduce legislation from the 2023 budget and fall economic statement.

Mark Burgess

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Mark was the managing editor of Advisor.ca from 2017 to 2024.