Tax On Split Income Rules and Its Exceptions

Articles

Tax On Split Income Rules and Its Exceptions

Published by:

David Johnson

Reviewed by:

Alistair Vigier

Last Modified: 2023-04-10

Are you wondering about the TOSI rules? Canada has a progressive rate tax system which means people with higher income pay a bigger share in taxes.

Therefore, many high-income earners often try to shift income to their lower-income earning spouses to take advantage of the lower tax rate.

For example, a dentist may want to incorporate as a professional corporation and bring his or her family members as shareholders so that the corporation can pay dividends to the family member who’s taxed at a lower rate.

Before 2018, there are “Kiddie tax” rules that prevent dividends from being shifted to children under the age of 18. The consequence is that they will be taxed at the highest interest rate when they receive such dividends.

What are TOSI Rules?

Since 2018, the Liberal government decided to adopt more aggressive methods to combat income splitting by expanding kiddie tax rules to all family members regardless of their ages.

This tax on split income (TOSI) rule has posed a huge obstacle for tax planning professionals. The TOSI rules basically apply to all types of income such as:

– Taxable dividends on shares of a corporation that you received directly, or through a partnership or a trust (other than mutual fund trust);

– Shareholder benefits from the ownership of a corporation conferred on you directly, or through a partnership or a trust (other than mutual fund trust);

– Income you received from a partnership or a trust if the amount is considered to come directly from either a related business or rental property by a particular partnership or trust under certain conditions; and

– A taxable capital gain or a profit realized from the disposition of a property.

There are some exceptions to dealing with TOSI.

However, it is still possible to avoid the application of TOSI as there are certain exceptions.

Excluded businesses

This exception applies to family members who are over the age of 18 and are engaged in the business on a “regular, continuous and substantial basis”.

To meet the threshold of “regular, continuous and substantial basis”, the family member must either work on average at least 20 hours per week in the business for the current year during the period the business operates or in the previous five years which do not have to be in succession.

However, one potential problem is that most people tend not to keep records of their working hours, especially in the context of a family business and the Canada Revenue Agency (CRA) hasn’t been clear about what type of evidence is required.

Recently, the CRA made a comment that they will consider all information made available. Therefore, it is highly recommended to document in detail if you intend to rely on this exception.

TOSI Rules and Excluded Shares

This applies to family members who are over the age of 25. To qualify, the individual must hold shares that meet the following conditions:

– The shares held by the individual represent at least 10% of the votes and value of the corporation; and

– 90% of the corporation’s income is not derived directly or indirectly from one or more other related businesses of the individual.

This exclusion is not applicable to shares held by individuals via a trust as there is a requirement that shares be held by individuals directly. In addition, individuals cannot hold shares in a professional corporation either.

Reasonable Return

If you are over the age of 25 and the above-mentioned exceptions don’t apply to you, there is still one exception – if you are paid a reasonable amount of income based on your contribution to the business.

The contribution may be evaluated based on a variety of factors such as work performed for the business, property contributed to the business, the risks taken by the individual and historical payment made to the individual.

One more exception is that when a family business owner reaches the age of 65, he or she can split income with the spouse or common-law partner and TOSI rules will not apply.