Marginal Tax Rates

A common term used in discussing income tax rates is one's "marginal tax rate." This refers to the effective tax rate applied to a certain "layer of income." Since there are different federal tax brackets and levels of federal and provincial surtaxes, a person's tax rate changes as income increases. An additional $1,000 of income may be taxed at a higher rate than the dollars of income that came before.

As mentioned on the previous page many of the Provinces now have their own tax brackets and those brackets, such as in BC, are indexed at different rates than the Federal tax bracket thresholds. This can mean that there are a considerable number of marginal tax rates as a person's taxable income moves up through the Federal and Provincial threshold levels. Therefore, for the purposes of examples given below I have provided information on marginal rates that would relate to larger chunks of income.
 

Marginal Tax Rates on Investment Income

Dividends and capital gains have different rates of inclusion in the calculation of net and taxable income.

Dividends from Canadian companies are grossed up to 125% of the amount received and a tax credit is given to reflect the taxes paid by the payer of the dividend. This tax credit (2/3 of the 25% gross up) is deducted from federal taxes as part of the calculation of basic federal tax.

Provinces have their own dividend tax credit rates. In BC, for example, the credit is 25.5% of the gross up or 5.1% of the taxable dividend.

In 2004, capital gains are 1/2 taxable.

In BC these forms of income attract less tax than interest income, shown as follows.

Brackets Based on BC Thresholds Interest Capital Gains Dividends
First tier 22.05% 11.03% 4.52%
Second tier 31.15% 15.58% 15.89%
Third tier 33.7% / 37.7% 16.85% / 18.85% 19.08% / 24.08%
Fourth tier 39.7% 19.85% 26.58%
Fifth tier 40.7% / 43.7% 20.35% / 21.85% 27.83% / 31.58%

Due to the different effective tax rates on investment income, it is therefore imperative to evaluate an investment opportunity on its after-tax rate of return, not the face rate of the investment.