TOSI = TAXES ON SPLIT INCOME
It’s been over a year since the Federal Government took the Country by storm with their MAJOR tax changes to income splitting (or sprinkling) or what many refer to as TOSI (pronounced toe-see). And just this past June 2018, the changes received Royal Assent which means the new tax laws are in effect for 2018 and later tax years. So what does this actually mean for small business owners.
Income splitting was a strategy used by many private corporations to share income among family members who were in a lower tax bracket. This, of course, applied to adults only as minor children were already subject to paying tax at the highest rate (started around 1999) if they received income from a private corporation. Split income that we refer to here generally includes dividends or interest paid by a private corporation (small business corporation) from a related business, either directly or indirectly. It also does not apply to those receiving a salary, although reasonability has existed for many years on what a related individual is earning.
An example of income splitting would be a spouse owning shares of their partners business, the spouse is further a stay-at-home parent with no other income and receives dividends from the family business and thus pays tax at a lower rate. Or having your adult children owns shares of your family business and while they are attending post-secondary school, you pay them dividends. Both of these situations, prior to 2018, would have allowed the spouse and/or adult children to receive income at a lower tax rate than if the spouse/parent running the business took all of the income and paid taxes at a higher rate.
As TOSI already existed for minors, these changes would only impact those 18+ and where they receive split income that would otherwise be subject to the highest rate of tax UNLESS they fall into one of seven exceptions.
EXEMPTIONS TO TOSI
Given the uproar of many to these tax changes, I would imagine the goal for many small business owners would be to pay a related individual split income where they benefit by having a lower tax bracket. The 7 exemptions are as follows.
TOSI rules will NOT apply when the income is received under Special Situations; i.e. death or martial breakdown. This includes:
- Income received from property received as a result of a parent passing away whereby the child is under 25 years old.
- Income received from property received as a result of any person passing away whereby the recipient is under 25 years old and was attending full-time post-secondary school or entitled to the Disability Tax Credit.
- Income received from property for a martial breakdown settlement.
- Income was a capital gain due to the deemed disposition of property upon the individuals death.
- Income was a capital gain from QSBC or QFP Shares, except for gains of a minor arising from the disposition to a related person.
TOSI rules will NOT apply for ALL adults when it is income received from an Excluded Business. An excluded business is where an individual is working for the business in an active capacity. This is considered to be about 20 hours per week on average and applies to the current year or any of the past 5 years.
For many small businesses that have family members working for them, tracking hours has not often been the case so historical time data may be difficult to obtain however going forward, CRA is suggesting that either the individual or business keeps payroll records, time sheets, schedules, log books, etc. CRA will also consider all relevant business history for prior years where tracking was not done.
TOSI rules will NOT apply for individuals aged 25+ when the income is received from Excluded Shares. To be considered excluded shares, ALL of the following conditions must be met:
- Less than 90% of the corporations business income was from the provision of services. i.e. at least 10% of the income is from sources other than services revenue.
- The corporation is not a professional corporation. i.e. lawyer, dentist, doctor, chiropractor, veterinarian, etc.
- Individual holds shares representing 10% or more of the votes and value of the corporation.
- All or substantially all of the income of the corporation is derived from a non-related business in respect of the individual.
This rule impacts small business corporations that involve the use of family trusts and holding companies. Special transition rules have been implemented for family trusts until the end of 2018 to allow corporations to complete corporate reorganizations to meet the “votes and values test”.
TOSI rules will NOT apply for individuals 25+ when the income does not exceed a Reasonable Return. Reasonable return is based on one or more of the following:
- Labour contribution – work performed in support of the related business.
- Property contribution – property contributed in support of the related business, either directly or indirectly.
- Risk incurred – risks assumed in respect of the related business
- Historical payments – total amounts paid or payable by any person or partnership to or for the benefit of the individual in respect of the related business
- Other relevant factors could be considered
Safe Harbour Capital Return
TOSI rules will NOT apply for individuals 18-24 when the income does not exceed a Safe Harbour Capital Return. This exception applies to individuals who have contributed capital to a related business but allows only a reasonable return up to a prescribed rate.
Safe Harbour Capital Return is determined as the return on property contributed by the individual to the related business. This is calculated by multiplying the highest prescribed rate of interest in effect for a quarter within the year and the fair market value of the property contributed by the individual in support of the business, pro-rated for the number of days it was used in the business during the year.
Arm’s Length Capital
TOSI rules will NOT apply for individuals 18-24 when the income is received from contributions of Arm’s Length Capital, similar to the Reasonable Rate exception. Therefore, the amount subject to TOSI can be reduced or eliminated if the individual is able to justify that the amount received represents a reasonable return of his or her property contributed to the business. This means that the business is not:
- Transferred to him or her by any means from a related person, other than an inheritance.
- Derived from income, gains or profit from a related business.
- Borrowed from any source, including arm’s length resources.
Spouse Over 65 Years Old
TOSI rules will NOT apply to income received by a specified individual if the same income would not be subject to TOSI if it was received by the specified individuals spouse AND the spouse is at least 65 years old in the particular year. So basically, if the spouse who is actively involved in the business is 65+ and the spouse who is not involved receives income from the corporation, TOSI will not apply.
TOSI is in effect for the 2018 and later years. If you are paying a spouse, child or related individual, you will want to find a way for TOSI not to apply under one of the seven exceptions listed above.
***This blog is for information only and not to be used as tax advice or planning without first seeking professional advice. Information is subject to change without notice.