Canada: The Specialized Tax Attribution Rules: Indirect Payments, Tax on Split Income, Corporate Attribution, and Revocable Trusts

Last Updated: February 27 2018

Introduction - Specialized Tax Attribution Rules

In another article, we focused on the basic tax-attribution rules and their exceptions. For an explanation of the on the basic tax-attribution rules and their exceptions, see here.

This article describes more specialized tax-attribution rules in the Canadian tax system—specifically, those applying to diverted payments, income-splitting with minors, holding corporations, and revocable trusts.

Indirect Payments and Transfers: Subsection 56(2)

A taxpayer may seek to reduce his or her taxable income by diverting payments to a third party, For example, an employee directs her employer to pay a part of her salary to her creditor. Or a creditor directs a debtor to make interest payments to the creditor’s mother.

Subsection 56(2) of the Income Tax Act includes the diverted payment into the taxpayer’s income if the payment:

  • was made to a person other than the taxpayer,
  • was made under the taxpayer’s direction or concurrence,
  • was made for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person, and
  • would have been included in the taxpayer's income if it had been made to the taxpayer.

The Supreme Court of Canada restricted the application of subsection 56(2) in the context of private corporations (see: R v McClurg; Neuman v R).

Kiddie Tax: Section 120.4

The declining number of two-spouse/one-income families caused a new trend in income splitting. Where both spouses earn similar income, there’s little scope for income splitting between them. Diverting income to minor children therefore becomes an attractive alternative.

In response, Parliament enacted section 120.4—also known as the “kiddie tax.” Simply put, a minor child draws top-rate tax on his or her “split income.”

In sum, a minor child’s split income captures five planning arrangements:

  • A trust established for a minor child’s benefit owns shares of a private corporation paying dividends. The grossed-up private corporation dividends are split income.
  • A trust established for a minor child’s benefit owns an interest in a partnership earning business income by providing property or services to an entity related to the minor child. For example, a lawyer sets up a trust benefitting her child. The trust is a partner in a limited partnership providing management services to the parent’s law firm. The law firm pays the partnership a management fee, which the partnership allocates to the trust. The trust, in turn, pays this amount to the child. The child’s income is split income.
  • A trust established for a minor child’s benefit operates a business that earned income from property or services provided to an entity related to the minor child. The income paid or payable to the child is split income.
  • The minor child (or trust established for his or her benefit) owns shares of a private corporation, and the minor child receives a shareholder’s loan, which triggers a taxable benefit under subsection 15(2). The subsection 15(2) benefit is split income.
  • The minor child (or a trust established for his or her benefit) owns shares of a private corporation and the minor child sells the shares to a non-arm’s length person. The full capital gain is deemed to be a dividend from the private corporation to the child, which is grossed up and taxed to the child at full rate as split income.

The kiddie tax only applies to the income earned in these five arrangements. It doesn’t apply to:

  • dividend income earned on shares of a public corporation, interest income, employment or self-employment income, or capital gains (other than those covered under 120.4);
  • income from property inherited from a deceased parent;
  • income from property inherited from a non-parent when the minor is either a full-time student at a post-secondary institution or eligible for the disability tax credit; or
  • trust or partnership income where the trust or partnership earns business income from services provided to an unrelated entity.

Further, the kiddie tax doesn’t applies if neither of the minor’s parents is a Canadian resident at any time during the year.

Finally, the kiddie tax ousts any otherwise applicable attribution rule. In other words, income that’s subject to the kiddie tax won’t be subject to an attribution rule under sections 74.1 or 74.2.

At the end of 2017, Parliament proposed various amendments to section 120.4 of the Income Tax Act that broadly expanded the rules beyond minors. Parliament also proposed that these amendments would apply to the 2018 and subsequent tax years. For more on the new tax on split income (TOSI) rules, see here.

Corporate Attribution Rules - Transfers to Non-Small-Business Corporations: Section 74.4

Section 74.4 of Canada’s Income Tax Act is an anti-avoidance rule designed to deter taxpayers from splitting income by transferring or loaning property to a corporation in which a spouse or related minor has at least a 10% interest.

Section 74.4 applies if :

  • an individual transferred or loaned property to a corporation that isn’t a “small business corporation,”
  • one of the main reasons for the transfer or loan is to both reduce the individual’s income and benefit the individual’s spouse or a related minor, and
  • the individual’s spouse or related minor owns at least 10% of the corporation’s shares either directly or indirectly.

If section 74.4 applies, the rule attributes to the transferor’s income a prescribed interest rate based on the FMV of the property transferred or loaned. This amount is attributed to the transferor regardless of whether the transferee corporation pays a dividend to the spouse or related minor.

Section 74.4 may lead to double tax since (i) the transfer results in the attribution of a prescribed rate of income to the transferor, (ii) the spouse or minor must report any dividend received from the corporation as income, and (iii) the dividend may stem from the property that the corporation received from the transferor.

Revocable Trusts: Subsection 75(2)

Trust income may be attributed to the settlor of the trust under subsection 75(2) of the Canadian Income Tax Act. This provision attributes to the settlor the income from property that the settlor transferred to a Canadian resident trust if either:

  • under the terms of the trust, the property may revert to the settlor;
  • the settlor has the power to determine, after the creation of the trust, who receives the property; or
  • during the settlor’s life, the trust can’t distribute the property without the settlor’s consent.

These conditions speak to the settlor’s power over property that the settler transferred into the trust. If the settler didn’t transfer the income-earning property into the trust, the attribution rule doesn’t apply.

In contrast to the trust attribution rules in sections 74.1 and 74.2, which attribute the beneficiary’s income to the transferring taxpayer, subsection 75(2) attributes the trust’s income to the settlor. So, this attribution rule applies whether the trust retains the income from the transferred property or pays the income to the beneficiaries. And the attribution occurs regardless of the relationship between the trust beneficiaries and the settlor. That is, subsection 75(2) isn’t confined to trusts for spouses or related minors. The idea is that the settlor shouldn’t be able to divert taxable income to the trust beneficiaries while continuing to retain substantial control over the trust.

In more detail, where 75(2) applies, it attributes to the settlor both:

  • the income or loss generated from the transferred property and
  • the taxable capital gain/allowable capital loss if the trust subsequently disposes of the property

These amounts are therefore not included in the trust’s income. And they aren’t included in the beneficiary’s income, even if they were payable to the beneficiary.

Also, as with the other attribution rules, subsection 75(2) attributes not only the income/loss/capital gain/capital loss of the transferred property but also the income/loss/capital gain/capital loss of “substituted property.” So, if the trust disposes of the transferred property and acquires a substitute, the attribution rule continues.

Attribution Tax Tips

Despite these attribution rules, some income-splitting strategies still remain viable—e.g., contributing to a spouse’s Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA).

If you unknowingly triggered an attribution rule, you may have underreported your taxable income. To avoid problems with the Canada Revenue Agency, contact one of our expert Canadian tax lawyers for advice on the remedies available, such as the Voluntary Disclosures Program.

If ignored, the attribution rules can undermine an assortment of tax planning structures. For example, section 74.4 can wreak havoc on an estate freeze, and subsection 75(2) can undermine a family trust. Moreover, when you trigger an attribution rule, your spouse or related minor, as the case may be, is jointly and severally liable for your tax on the attributed amount. Do yourself and your loved ones a favor and discuss proper tax planning with one of our best Toronto tax lawyers.

The information is thought to be current to date of posting. Income tax law changes frequently and content may no longer reflect the current state of the law. This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Contact the Author?
Click here to email the Author
In Association with
In Partnership with
Other Canada Advice Centres
Competition and Antitrust
Mergers and Acquisitions
Labour and Employment
More Advice Centers
Useful Resources
Forms available to download for income tax filing in Canada.
Hear David J. Rotfleisch discuss timely and highly topical tax matters during appearances and interviews with specialist publications.
Useful explanatory videos of income tax matters.
The following questions and answers are based on the proposed measures that were announced on December 7, 2015.
The official Government website of the CRA.
This guide is for any person who deals with the Canada Revenue Agency (CRA). The guide gives you information on the 16 rights set out in the Taxpayer Bill of Rights and explains what you can do if you believe that the CRA has not respected your rights.
The Office of the Taxpayers' Ombudsman (OTO) works to enhance the Canada Revenue Agency's (CRA) accountability in its service to, and treatment of, taxpayers and benefit recipients through independent and impartial reviews of service-related complaints and systemic issues.
Ontario personal income tax is an annual tax collected from individuals who are Ontario residents on the last day of the tax year or have income earned in Ontario for the tax year.
The following documents provide instructions for filing your 2015 income tax return.
If you earned income in B.C. or operated a Corporation with a permanent establishment in B.C. last year you need to file an income tax return. Find out when you need to file your income tax return, and if any tax credits or rebates apply to you.
Generally, a corporation must file an Alberta corporate income tax return (AT1) for each taxation year during which it has a permanent establishment in Alberta.
Tools
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions