Eligible dividends vs non-eligible dividends
Dividends from corporations usually show up on a T5 slip to be included in your personal taxes. T5 slips for dividends show the actual amount of dividends taken or declared, as well as a "grossed-up" amount and a dividend tax credit. The percentages used for the "gross-up" and the dividend tax credit are different for eligible and non-eligible dividends. This is what causes eligible dividends to be taxed more favourably on your personal taxes compared to non-eligible dividends.
Eligible dividends
Eligible dividends are generally received from public corporations (who do not receive the small business deduction) or private corporations with high earnings (net income over the $500,000 small business deduction). Those types of corporations pay corporate tax at higher rates than small businesses. A portion of income that is taxed at the higher corporate tax rate flows into a corporation's general rate income pool (GRIP) balance and accumulates. GRIP represents the after-tax amount of income that has been subject to the higher corporate tax rate.
Eligible dividends are issued from a corporation up to the amount sitting in the GRIP pool. Eligible dividends are "grossed-up" to reflect corporate income earned, and then a dividend tax credit is included to reflect the higher rate of corporate taxes paid.
Non-eligible dividends
Non-eligible dividends are received from small business corporations that earn under $500,000 of net income (most companies). These dividends are also "grossed-up," and they also receive a dividend tax credit. However, the percentages used are different to reflect corporate tax paid at a lesser rate. Therefore no income is taxed at the higher corporate rate and no GRIP pool is created, meaning eligible dividends are not able to be issued.
Summary
Eligible dividends are taxed more favourably than non-eligible dividends because the corporation has paid tax at higher rates and the individual receiving the dividend pays less.
Dividends are taxed at lesser rates than employment income and many other types of income in your hands personally. The dividend tax credit reflects that some taxes have already been paid at the corporate level.
Eligible dividends indicate that the corporation has paid tax at higher rates and therefore the individual receiving the dividend pays less.
Learn more about types of dividends.