For the tax years starting January 2018, TOSI Rules are applicable. Expanded TOSI rules apply to adult individuals receiving amounts from the “related business”.
Prior to 2018, income sprinkling was used as a tax planning tool in Canada, where low-income family members were issued dividends from a corporation. Individuals under 18 years of age were subject to “kiddie tax”. This has changed now and Tax-on-Split-Income rules have been expanded to include adult individuals.
TOSI rules apply for “specified individuals” who receive income from “related businesses”.
What is a “specified individual” for TOSI Rules?
ITA subsection 120.4(1) re-defines the “specified individual now”.
Generally, an individual who is a resident of Canada at the year-end.
Under the new definition, an individual (other than a trust) is a specified individual for a taxation year if two conditions are met:
- the individual is a resident of Canada at the end of the taxation year or, if the individual died during the taxation year, the individual was a resident of Canada immediately before their death; and
- if the individual has not attained the age of 17 years before the year, the individual has a parent who is resident in Canada at any time in the year.
What is a “related business” for TOSI rules?
In respect of TOSI rules, a “related business” is a business in which, at any time during the year, an immediate family member is involved. Such family members include; spouse, parents, children and siblings. A related business can be any business whether it’s a corporation, operated personally or a partnership, or a trust.
How income is taxed if TOSI rules apply?
If TOSI rules apply the income at the recipient’s hand is taxed at the highest personal tax rates. There are certain exclusions and if the income falls within one of those exceptions it is taxed at the marginal tax rate of the individual.
Does TOSI apply only on dividends?
TOSI does not only apply to dividends; however, it is applicable to any income from a related business. Though dividends are the most common form of income which gets caught under TOSI rules other forms of income such as, capital gains, interest received or shareholder benefits from a related business also attract the application of TOSI rules. Salary received by an individual meeting the reasonableness criteria is not considered a split income.
Specific Exceptions from TOSI rules
While it is good to start with assuming that TOSI rules apply if you are receiving an income from family business (related business) unless you fall within specific exclusions as provided by TOSI rules.
TOSI Exception: Amounts received from “excluded business”.
TOSI does not apply on the amounts received from an excluded business. An excluded business is defined as a related business in which an individual is “Actively engaged” during the tax year or in any five prior tax years. “Actively engaged” means substantial regular and continuous involvement in business activities.
You are considered actively engaged in a related business if you work for the business at least 20 hours per week on average for the current year or if you meet the requirements for any five prior years. These prior years do not need to be consecutive. As a result, the amounts paid to the individual are reasonable for the work performed by an individual for the business.
In such a case record-keeping is the key to determine if TOSI rules apply or not.
TOSI Exception: “Excluded Shares”
If an income derived from the business or Capital gain on the disposition of the shares of the related business by an individual aged 25 or more who holds excluded shares is not considered split income.
An individual owns “excluded shares” of a related corporation where:
- The corporation is NOT a Professional Corporation and the income generated from services (professional) is less than 90% of the corporation’s business income.
- The individual holds 10% or more voting shares and value of the corporation
- The corporation in which an individual holds the shares does not derive its all or substantially all income from another related business of the individual.
TOSI Exception: “Reasonable Return”
If an individual, aged 25 or more, derives income from a “related business” and the payments received represent a “reasonable return” which meet “reasonableness criteria” is excepted from TOSI rules.
It includes work performed for the business when the property is directly or indirectly contributed to the business, when an individual assumes risks in respect of the business, or when any person or partnership have amounts paid or payable for the benefit of individual in respect to a related business.
TOSI Exception: “Safe Harbour Capital Return”
An individual aged between 18 and 24 derives a return on property contributed for related business and does not exceed a prescribed capital return which is determined by a formula.
TOSI Exception: “Reasonable Return on Arm’s Length Capital”
An individual aged between 18 and 24 derive a reasonable return on property contributed as an Arm’s length capital.
Some Common Examples of TOSI Rules application
- A family business famco pays a dividend to an adult child who is studying in a school and have never participated in any business activity. Such a dividend will be having a tax on split income (TOSI) applicable to it since the individual is not actively engaged in the business.
- A parent lends the money to 25 years old child to start a business. The rate of interest charged is higher than the rates generally offered by financial institutions, but the child cannot get funding from financial institutions due to increased business risk involved in his newly opened business. Other lenders who gave the funding to him also have a similar rate of interest. Such an interest payment to parents from the child’s business is considered as an “excluded amount” from split income since it represents a reasonable return on the property contributed by parents.
- Other detailed examples can be found on this CRA guidance on the TOSI ruled for adults.
TOSI rules are very complex and usually need advice from a corporate tax accountant or professional tax preparation service who understands the complexities and how to navigate them.
The above article is for general information purposes and should not be relied on while making any decision. Further, this article is not being updated since first authored in 2019, please consult your corporate tax accountant to get updated tax advice.
Maroof HS CPA Professional Corporation is an Ontario based professional accounting firm and provides a wide range of tax and accounting services including corporate tax planning, individual tax planning and preparation, accounting and reporting for businesses and business advisory service.