Tax Friction
Tax Friction is the tax cost of holding a dividend investment in a non-registered account rather than a sheltered account. It is the gap between what your dividend generates gross and what you actually keep after CRA’s share. Tax Friction is not a fixed number — it shifts with your marginal tax rate, dividend type (eligible vs. non-eligible), and whether your holding sits in a TFSA, RRSP, or non-registered account.
How Prospyr uses it
The Portfolio Conversion Tool’s Tax Friction Warning flags when a modeled conversion would generate significant non-registered income — displaying the after-tax income figure alongside gross yield so the real cost of the conversion is visible before you act. The Tax Bracket Calculator quantifies Tax Friction at your specific income level by showing combined federal and Ontario marginal rates for eligible dividends, non-eligible dividends, interest, and capital gains side by side. This comparison is the foundation of account-type optimization: the same holding in a TFSA versus a non-registered account can produce materially different net income depending on your bracket.
Why this matters for Canadian investors
Tax Friction is uniquely layered for Canadian investors. Eligible dividends from Canadian corporations receive the enhanced dividend tax credit, which lowers their effective marginal rate — sometimes to near zero at lower income levels. Non-eligible dividends and foreign dividends carry significantly higher friction. The CRA gross-up mechanism also inflates your reported net income, which can trigger clawbacks on OAS and other income-tested benefits at higher income levels. Understanding Tax Friction by account type and dividend type is not optional for tax-efficient income investing in Canada — it is where most of the optimization happens.