Income Sprinkling Rules / Tax on Split Income (TOSI) – enacted Jun 2018

Legislation that contained the legalization of Cannabis obtained Royal Assent on Jun 21, 2018 (Bill C-74). Included in this Bill, were also the complicated rules covering Income Sprinkling, widely referred to as TOSI (Tax on Split Income) that were announced in December 2017.

The government’s objective is to eliminate the benefits of income splitting where the recipient of the income (a related family member) has not made a sufficient contribution to the family business. To accomplish this, they are subjecting income received under these rules to the highest marginal tax rates, thus eliminating any advantage achieved through income splitting. Since Jan 2000, there were such rules in place for those under the age of 18 (known as “Kiddie Tax”) – this has now been expanded to cover a broader age category.

The TOSI rules apply to essentially any income amounts, outside of a reasonable salary, including the following

  • Taxable dividends from non-public corporations (excluding capital dividends) or shareholder benefits
  • Partnership income received from a Related Business, or rental income with involvement from a related person
  • Taxable dividends from non-public corporations (excluding capital dividends), shareholder benefits, Income from a Related Business, or rental income with involvement from a related person, received from a trust
  • Debt obligation income from a non-public corporation, partnership or trust
  • Gains from the sale of non-public corporation shares, or income from property with historical Tax on Spilt Income.

Even income from foreign private companies would also be caught under the above rules.

Consider the following situation:

A husband and wife involved in a family incorporated service business having 50% ownership each. Husband is active in the business. Wife is not active. They each draw a dividend of $50,000 for 2018. If this were there only source of income and there were no other credits,

Where dividends are ineligible dividends*

Husband would pay taxes of $2,951

Wife would pay taxes of $23,420

Wife would be subject to the highest marginal tax rate on ineligible dividend of 46.84% for 2018 because of the new TOSI rules.

*Ineligible dividends are dividends paid out of profits that were subject to corporation tax at the small business tax rates.

Where dividends are eligible dividends*

Husband would pay taxes of $0

Wife would pay taxes of $19,670

Wife would be subject to the highest marginal tax rate on eligible dividend of 39.34% for 2018 because of the new TOSI rules.

*Eligible dividends are dividends paid out of profits that were subject to full corporation tax rates.

There are several exclusions to the TOSI. The rules vary depending on the age of the individual. This could be summarized based on age category as:

Exceptions
Applicable Ages
Under 18
18-24
25+
65+
Inheritance
X
X
X
X
Breakdown of Relationship
X
X
X
X
Death
X
X
X
X
Qualified capital gains or qualified farm or fishing property
X
X
X
X
Excluded Business
X
X
X
Excluded Share
X
X
X
Safe harbour return
X
Reasonable return – “arms length capital” only
X
Reasonable return
X
X
Retirement
X

As one sees from the chart above, the age categories with rule changes are:

  • Under 18 yrs
  • Age 18-23
  • Over Age 24
  • Over Age 64

The exclusions explained

  • Amounts from property received on death of another person (a) who is parent (b) from anyone if full-time post-secondary student or disabled, provided under 24 yrs.
  • Property obtained by spouse/common law partner on separation/divorce
  • Taxable capital gain on one’s death
  • Taxable capital gain from sale of qualifying small business corporation shares, farming or fishing property unless under 18 and non-arms length,
  • If at least 18, amount during the tax year,
    • Is from an Excluded business

      This exclusion applies to those over 18 yrs. To qualify for this exclusion, the family member must be engaged on a regular, continuous and substantial basis in the business. This exclusion would apply if the family member has worked at least 20 hours a week on average in 5 years at any time in the past. Any dividends they receive now or in the future from the family business will not be subject to TOSI.

    • Is not from Related business

      If we were doing a TOSI study for Mr. A, a related business would be, a business carried out by a person related to Mr. A. Such a business would cover proprietorship, partnership, corporation or trust. For this purpose, the person related to Mr. A must be actively engaged on a regular basis. If partnership, any percentage ownership by the person related to Mr. A will result in the partnership being considered a related business. If corporation, if the person related to Mr. A owns at least 10% of the value of the corporation, then it would be a related business.

      A related person is father, mother, spouse/common law partner, brother, sister, son, daughter. The rule extends to grandparents, grand children and in-laws of this person.

  • If 18 but under 24, amount is based on bright-line tests, that are
    • Safe harbour capital return

      This is the highest prescribed quarterly interest rate for the year multiplied by the fair market value of property contributed by the individual for the year. At present (Sep 2018) the prescribed rate is 2%. If an individual had $100,000 invested in the business, the individual could take $2,000 for the year as the safe harbour amount, that would not be subject to the TOSI rules

      – or –

    • Reasonable return considering arm’s length capital

      Arm’s length capital is property contributed to the business by an individual not derived from a related business or was not borrowed or transferred from a related person.
      Reasonable return has not been defined but would assume to be a return commensurate with the risks involved in the business.

 

  • If 24 & over (a) reasonable return or (b) excluded shares
    Reasonable return is a more generous calculation than safe harbour return or reasonable return considering arm’s length capital as it will include property contributed indirectly as well.Excluded shares are generally shares that represent at least 10% of the votes and value of the company. In addition to this requirement, the exclusion only applies to shares of corporations where less than 90% of the business income of the corporation is from the provision of services, and 90% or more of all the income of the corporation is not derived directly or indirectly from one or more other related businesses of the individual. Excluded shares also do not include shares of a professional corporation.

 

  • If over 64 and the other spouse/common law part is actively engaged in the business.

If TOSI is applicable, even some of the regular tax credits are removed. Only three tax credits are allowed to set-off against income subject to TOSI

  • Dividend tax credit
  • Foreign tax credit
  • Disability tax credit

The following are not allowed:

  • Personal allowances
  • Donation tax credit
  • Medical expenses credit

Please contact us to discuss how the new rules will impact your family’s tax planning.