Edmonton... The Alberta government is enhancing the province's dividend tax credit and boosting the small business income threshold to encourage greater investment and help ensure Alberta remains the place to do business, announced Finance Minister Shirley McClellan.

"We strive to maintain a competitive tax system in Alberta because it's an integral part of the province's prosperity," said McClellan. "Eliminating the double taxation of corporate dividends will enhance Alberta's investment climate. Increasing the income threshold promotes small business growth."

Currently, dividend income is taxed twice: first when the income is earned in the corporation, and again at the personal income tax level when investors receive the dividends. To address this double taxation, federal and provincial governments provide dividend tax credits on personal income taxes as an offset. However, the dividend tax credits have not fully offset taxes paid at the general corporate rate.

Earlier this year, the federal government announced it is enhancing the dividend tax credit for eligible corporate dividends beginning in 2006, eliminating double taxation by 2010.

Alberta will parallel the federal changes and eliminate double taxation by increasing the tax credit on eligible dividends paid out of corporate income taxed at the general rate. The changes will be implemented over four years and will apply to eligible dividends received on or after January 1, 2006.

The Government of Alberta has taken steps in the past several years to benefit small businesses, cutting the small business tax rate in half to three from six per cent, and doubling the small business income threshold to $400,000. The amount of income eligible for the small business deduction will be increased further to $500,000, phased in by 2009.

At the same time, the province will correct an inadvertent benefit provided when the small business tax rate was reduced to three per cent. The dividend tax credit was not adjusted to take into account the small business tax rate reduction between 2001 and 2004. This provided an overly generous dividend tax credit for income taxed at the small business rate and flowed out as dividends.

"The changes to the dividend tax credits ensure a fair and equitable tax system for all Albertans," said McClellan. "At the same time, they also encourage small businesses to retain more of their income for growth. This is further enhanced with the boost to the small business threshold, which increases the amount taxable at the lower small business rate."

The table below illustrates the current inequity between the tax treatment of corporate and small business dividends and how the adjustments will provide more equitable taxation.

The changes to the dividend tax credits and the small business threshold will be phased in between 2006 and 2009 to allow businesses and investors time to adjust. Further details are included in the attached backgrounder.

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Attachments: Backgrounder

This news release is available on the Alberta Finance homepage at: www.finance.gov.ab.ca

Edmonton... Changes to Alberta's tax system over 2006 to 2009 will eliminate the double taxation of dividends from large corporations and restore proper treatment of dividends from small businesses. The government is also increasing the small business income threshold to $500,000 from $400,000 during the same period.

Corporate income flowed out to investors as dividends is taxed twice, once at the corporate level, and again at the personal level when the investor receives the dividends. To address this double tax, both the federal and provincial governments provide dividend tax credits at the personal level in recognition that taxes have already been paid at the corporate level. Until now, dividend tax credits were generally established to fully offset taxes paid at the small business rate, leaving some level of double tax on dividends flowed from income taxed at the general corporate rate.

Until 2006, a single-tiered dividend tax system was used. All dividend income received by individuals was treated the same, regardless of whether the related business income in the corporation was taxed at the small business or the general rate. Under the previous system:

• Taxpayers grossed-up the dividends they received by 25 per cent to approximate corporate income before tax. The grossed-up amount was included as income for personal tax purposes.
• Taxpayers could then claim non-refundable federal and Alberta dividend tax credits, of 13.33 per cent and 6.4 per cent respectively, calculated on the grossed-up amount.

Effective for 2006, the federal government has implemented changes in how dividend income is treated. These changes introduce a second dividend tax credit tier, applicable to dividends paid from corporate income taxed at the general corporate rate (eligible dividends). When fully phased in, these changes will eliminate double tax on those dividends. Under the new federal system:

• Eligible dividends will now be grossed-up at 45 per cent and receive a dividend tax credit of 19 per cent on the grossed-up amount (second tier). This will eliminate double tax at the federal level by 2010, as the 19 per cent dividend tax credit is based on the proposed 2010 federal corporate tax rate.
• Dividends paid from income taxed at the small business rate will still be subject to the 25 per cent gross-up and the 13.33 per cent federal dividend tax credit (first tier).

With this announcement, Alberta is also removing double tax on eligible dividends. This decision applies to eligible dividends received on or after Jan. 1, 2006, and will increase returns for Alberta investors and encourage further investment.

Under the Tax Collection Agreement with the federal government, eligible dividends will be included in Alberta taxable income and grossed-up by 45 per cent. These dividends will qualify for an enhanced Alberta dividend tax credit, which will be increased in stages over the 2006-2009 tax years as follows:

Between 2001 and 2004, the Government of Alberta reduced the small business tax rate to three per cent from six per cent, and doubled the small business threshold to $400,000 from $200,000. However, an unintended benefit resulted because the dividend tax credit was not adjusted to take into account the small business tax rate reduction. This provided an overly generous dividend tax credit for income taxed at the small business rate and flowed out as dividends.

To ensure the tax system is fair and equitable in respect of all sources of income for all Albertans, the government will adjust the dividend tax credit applicable to dividends paid out of corporate income taxed at the small business rate and grossed-up by 25 per cent. This will correct the inadvertent benefit and restore proper tax treatment of small business dividend income.

At the same time, the government will increase the small business threshold to $500,000. This will allow small businesses to earn an additional $100,000 of income that is eligible to be taxed at the small business rate of three per cent for a potential saving of $7,000 per year. The adjustment will further encourage growth of, and investment in, small businesses in Alberta. These changes will be phased in over four years as follows:

These changes increase fairness and equity in Alberta's tax regime. They are consistent with the government's broad-base, low-rate tax policy, and contribute to the province's ability to keep taxes as low as possible for all Alberta taxpayers.

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To call toll-free within Alberta dial 310-0000.

This news release is available on the Alberta Finance homepage at: www.finance.gov.ab.ca

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