Key points to keep in mind with recent tax changes
On December 13, 2017, the Department of Finance released the much-anticipated revised rules for the tax on split income, or TOSI. The revised TOSI rules address income sprinkling between family members, and apply to the 2018 and subsequent taxation years.
The rules are essentially designed to counteract the strategy used by small business owners and incorporated professionals to sprinkle their income with family members that are in lower tax brackets and hence incurring a lower overall total tax liability for the family. The income was generally sprinkled amongst family members by way of dividend payments from the business.
Prior to the latest revisions, there were rules in place to deal with the concept of income sprinkling. The old TOSI rules applied tax at the top marginal rate when certain types of income were split with a family member under the age of 18. The new rules will extend the TOSI rules to certain family members over the age of 17, with some specific exclusions as outlined by the government.
What are the exclusions?
A. Exclusions Based on Reasonableness
For individuals from 18 to 24 years of age:
For these individuals, a reasonable return is based on the fair market value of property contributed to the business and calculated as either equal to or less than the prescribed CRA rate which currently is one per cent.
For individuals 25 years of age or older:
Amounts would be considered reasonable having regard to the following factors in respect of the relative contributions of the individual and related persons:
» the work performed in support of the related business,
» the property contributed directly or indirectly in support of the related business,
» the risks assumed in respect of the related business,
» the total amount paid or payable directly or indirectly to or for the benefit of the individual and related individuals in respect of the related business, and
» “such as other factors as may be relevant.”
B. “Excluded Business” for individuals 18 or Older
An Excluded Business is defined as a business if the individual is actively engaged on a regular, continuous and substantial basis in the activities of the business in the taxation year or in any five previous taxation years.
To provide some certainty to this definition, an individual is deemed to be actively engaged on a regular, continuous and substantial basis if the individual worked in the business at least an average of 20 hours per week during the portion of the year in which the business operated.
C. “Excluded Shares” for Individuals 25 or Older
The Department of Finance provided some level of income splitting for adults aged 25 or older by excluding income from or taxable capital gain or profit from the disposition of certain shares, if they meet the definition of “Excluded Shares”.
These are shares in a private corporation which give you 10 per cent of votes and value of the corporation. This however, does not include professional corporations or service businesses (such as the professional practice of an accountant, dentist, doctor, lawyer, veterinarian or chiropractor).
D. Other Exclusions
Spouse is 65 Years of Age or Older
In order to provide some income splitting on income from a private corporation for those aged 65 or older, the rules provide that split income to an individual will be excluded from TOSI. In this situation, you could split income with the business owner’s spouse, provided the owner meaningfully contributed to the business and is aged 65 or over.
If property is acquired by or for the benefit of an individual as a consequence of the death of another individual (either by bequest or inheritance then the labour contributions, capital contributions, risks assumed and amounts paid or payable factors to the deceased individual are to be included for the purpose of applying the definition of a reasonable return to the individual.
Qualified Farm or Fishing Property / Qualified Small Business Corporation Shares
Taxable capital gains from the disposition of property that is either a qualified farm or fishing property or qualified small business corporation shares are excluded from TOSI whether or not the enhanced capital gains exemption is claimed.
Harjit S. Sandhu, CPA, CA, Partner - DMCL LLP