True to their word, the Department of Finance Canada released their revised legislative proposals regarding income splitting with family members. The proposals released on July 18, 2017 met with considerable criticism from business owners, tax professionals and other interested parties, sending Finance back to the drawing board. The following are some key aspects to this revised legislation which is scheduled to take effect for 2018:
Tax on Split Income (TOSI)
TOSI is a tax that will be charged on income earned by “specified adult individuals” 18 and over that is caught by the application of this new tax. TOSI will be at the highest marginal tax rate and any personal tax credits on this income would be denied, except for the dividend tax credit and the foreign tax credit. There are some exemptions from the application of TOSI that we’ll discuss below.
An excluded business is essentially a business for which the individual related to the business receiving a remuneration (salary or dividends) will not have to “value” their labour contribution if they make a “meaningful direct labour contribution” in the year or in five previous years (non-sequential). Finance is generally defining this term as an average of 20 hours per week on a regular, continuous and substantial basis for the year, or part-year the business operated if it’s a seasonal business. Below this threshold it would be a “question of fact” as to whether a meaningful contribution was made. If CRA would fail to be satisfied that a meaningful contribution was made, then TOSI would be applied to the amount “deemed by CRA” to be unreasonable. Undoubtedly, this will end up in the courts in many cases.
These rules will apply for family members but will not extend to aunts, uncles, nieces and nephews.
TOSI will not apply to individuals over 24 years in age on income received on “excluded shares”. Corporations meeting the test of excluded shares would be the following:
- Less than 90% of its income comes from the sale of services.
- It is not a professional corporation (incorporated accountant, lawyer, doctor, dentist, etc.)
In addition to the above, to be excluded from TOSI as per the “excluded shares” criteria, the specified adult individual would need to own directly (not through a family trust) at least 10% of the outstanding shares of the corporation in terms of votes and value.
- TOSI will not apply to income from a business or shares for the spouse of a business owner who is 65 years of age or older and who qualifies for the meaningful contribution definition in the year or in any five previous years. This would allow income splitting similar to the rules for qualified pension income.
- TOSI also will not apply to inherited shares if TOSI would not have applied to the person who passed away.
- Income derived from property subject to a marriage or common-law breakdown will be exempted from the TOSI rules.
- Individuals between 18 and 24 will not be subject to TOSI at the highest prescribed rate of return in effect for each quarter, on the fair market value of the property they contributed to the related business. As the contribution by an individual in this age group would generally be nominal, the income not subject to TOSI would also generally be nominal.
TOSI is a punitive tax on income distributed to individuals of a family who do not contribute (or have not contributed in the past) in a sufficiently meaningful way to the family business or do not hold a direct ownership of at least 10% in the family business, and the family business cannot be primarily a service business or a professional corporation.
There are several more aspects to this new legislation that may require a detailed review of the circumstances to see if TOSI is at risk of being applied. If you feel you may be impacted please give us a call to discuss your specific case and how you could improve the audit-proofing of your case.