Ontario Budget Favours Dividends

The Ontario Budget has just been introduced. According to KPMG:

On the personal tax front, Ontario maintains its original plan to increase the dividend tax credit rate for grossed-up eligible dividends, despite changes to the federal dividend gross-up factor and dividend tax credit rate on eligible dividends. As a result, Ontario’s tax rate on eligible dividends will effectively be reduced.

The 2008 federal budget announced changes to the tax on eligible dividends that would reduce the gross-up factor applying to eligible dividends received by Ontario individuals, beginning in 2010. Ontario proposes to maintain its plan announced in August 2006 to increase the dividend tax credit rate on grossed-up eligible dividends to 7.4% in 2009 (from 7.0% in 2008) and to 7.7% in 2010 and subsequent years.

Taking into account these changes, the top marginal tax rates applying to eligible dividends for Ontario resident individuals will be as follows:

Top Marginal Tax Rates for Eligible Dividends

























In effect, the Ontario top marginal tax rate on eligible dividends will drop to 7.4% (from 7.8%) by 2012. Overall, the combined federal and Ontario top marginal tax rate on eligible dividends will increase to 26.7% (from 24.0%) by 2012.

The quoted top marginal rate is very different from the 30.19% in 2012 estimated earlier!

4 Responses to “Ontario Budget Favours Dividends”

  1. prefhound says:

    This is quite decent and maintains the integration so integral to the Canadian corporate tax system. Looking at top marginal rate:
    Dividend Equiv Factor in Ontario in 2008 = 1.419
    This proposal = 1.368
    Math after Feb federal changes = 1.303

    Now, instead of an 8.2% hit in pref values, we get only 3.6% and that’s in 2012.
    Meanwhile, prefs are at least 10% undervalued, so this bit of bad news is in the noise and James was right to warn us Feb 27 not to get too excited just yet.

  2. madequota says:

    Hi ph . . . can you elaborate on why you think prefs are at least 10% undervalued? . . . the market, as we know, thinks they’re fully valued, and BMO’s IPO yesterday would tend to suggest that they think the market’s over-valued.

    I’d like to believe what you suggest is true, but it looks like you might be the only investor out there that thinks so.


    ps . . . the secondary underwriters (Etrade, etc.) are offering the BMO issue; in the past this has almost certainly guaranteed that the offering is over-priced, and destined to open underwater. It also confirms that the so-called greenshoe is not being fully subscribed. ouch. again.

  3. prefhound says:


    I am (mostly) a long term investor, so I take the view that pref share spreads to comparable corporate bonds or even Canada bonds will trade in a “normal range” most of the time. From time to time they may become overvalued or undervalued compared with long term relationships when the spreads are “too narrow” or “too wide”, respectively.

    Right now, I think pref spreads to corporate bonds (on a bond equivalent yield basis) are “too wide” by 100 bp or more (and arguably, corporate spreads are too wide to governments, but that is a separate story). 100 bp with a bond equivalent factor of 1.4 = 70 bp too high for pref yields.

    Multiply this times durations of around 14 and I get discount prefs about 10% undervalued, even if corporate yields stay where they are.

    Stable spreads as a driver of long run valuation are an equilibrium-type factor. In the short term, we know dynamic buying and selling sets the price — and factors like lots of new supply (last year and this year) are important in the short term.

    As a long term investor, I put more weight on equilibrium conditions as they might exist in 2-5 years than I do on where things trade today.

    Using the same logic, I would say government bonds are “overvalued” with small spreads to expected inflation, and I worry that stocks are “overvalued” with high profits/GDP compared to post-war history.

    Furthermore, as a long-term investor, I care about what income I can generate in an annuity sense over my remaining life. If a pref share portfolio drops 15% in the short term, but yields therefore go up 15%, I am almost in the same position (except for very slight dipping into capital to maintain the annuity — which is negligible for inflation indexed annuities). I see no need to get excited or panic from price moves. Actual defaults, however, are another story.

    We both know that over and under-valuation can last quite a while, continuing a perverse trend for longer than expected. Nevertheless, within a diversified portfolio, I try to position myself in the undervalued, rather than overvalued, securities, so “low” pref prices are an opportunity to add more undervalued holdings to my portfolio.. And I use the same logic of taking advantage of misaligned values in my pref arbitrage trades, sometimes helpfully flushed out by Mr. Hymas.

    As to the BMO issue, I use both TD Waterhouse and E*Trade. Whenever TD Waterhouse has sold out in a few hours (as now), it has usually been OK for the new issue (providing the market doesn’t shift enormously prior to settlement). We will have to see if the last two days of weak pref prices are enough to dump this issue underwater.

  4. […] two tax changes scheduled to have an effect on preferreds in the next few years, Federal Bad and Ontario Good, netting out to a modest […]

Leave a Reply

You must be logged in to post a comment.