Canada: Avoiding And Getting Off Of The TOSI Highway

On July 18, 2017 the Federal Finance Minister announced proposals to change the tax rules related to income splitting using private corporations. The original proposals were subsequently withdrawn in October, re-released in December and after further changes the proposed legislation was included in Bill C-74 in March 2018. Bill C-74 received Royal Assent on June 21, 2018 and the new tax on split income (TOSI) rules are now in effect as of the beginning of 2018.

Income that is treated as split income (SI) is taxed at the top marginal tax rate of the recipient instead of at the person's marginal tax rate. TOSI has been in place for many years but only applied to income received by minors. The new rules expand the types of income that are treated as split income and broadens its impact beyond minors to include adults.

Under the new TOSI rules, SI can generally include: i) dividends and shareholder benefits from private corporations; ii) certain partnership and rental income; iii) trust income derived from i) or ii); iv) interest on loans to private corporations, partnerships or trusts; and, v) capital gains from the sale of shares of private corporations. 

Several recent Tax Alerts have dealt with issues in the proposed TOSI changes. The purpose of this article isn't to provide an in-depth analysis of the new TOSI rules but to provide a general framework for understanding how the new TOSI rules work.

When trying to understand how the new TOSI rules work, compare it to a time when you may have accidentally turned onto a toll highway and didn't have any money with you with which to pay the toll. Prior to arriving at the toll booth, there are usually signs for off-ramps that provide you with several opportunities to exit the highway to avoid paying the toll. The TOSI rules are similar to this experience. If you receive any of the types of income previously described as SI, you have entered the TOSI highway. The TOSI legislation provides a number of criteria which exempt you from the TOSI if you meet the requirements. As you proceed on the TOSI highway there will be signs describing the criteria you must meet to take the next exit ramp. If you meet the exception described on the exit sign you are able to take the off-ramp and exit the TOSI highway. Eventually you will pass by all of the exit opportunities because you have been unable to meet any of the exceptions and you will come to the toll booth and have to pay the fee (the TOSI) as part of your taxes for the year.

The following is a summary of the exceptions (exit ramp opportunities) to the TOSI rules:

  • Does the income come from a business where you are actively engaged on a regular, continuous and substantial basis in the activities of the business in either the current year or any five of the previous years? This is referred to as the 'excluded business' test and if met, the income is not SI.
    • A deeming rule states that this test is met if the person worked an average of 20 hours a week during the portion of the year that the business operated.
    • If the 20-hour average test is not met a factual examination of the activities will need to be done to support a conclusion that the person is actively engaged on a regular, continuous and substantial basis in the activities of the business and any conclusion will be subjective and may be open to challenge.
  • The income comes from a corporation that is not a professional corporation, you are 25 years or older, you own shares that account for 10 per cent or more of the votes and overall value of the corporation, the corporation's income from the provision of services in the prior year is less than 90 per cent of the total business income for that year and in the prior year less than 10 per cent of the income of the corporation was derived directly or indirectly from a related business other than a business carried on by the corporation. This is referred to as the 'excluded shares' test and if met, the income is not SI.
    • The legislation does not provide a definition of what is meant by the provision of services.  Generally speaking, it would imply an absence of a physical or tangible good but it is not clear what percentage of the sale needs to relate to the tangible product to ensure the revenue is not from the provision of services. There will undoubtedly be disagreement on interpreting this criteria.
    • These tests need to be met at the time the income is received. However for 2018, if all of the conditions are met by the end of the year they are deemed to have been met at the time the income was received. As a result, there is an opportunity to correct deficiencies before the end of the year to avoid the application of TOSI in 2018.
  • If you are under 25 years of age and received the property on which the income was received as a consequence of the death of a parent, the income is not SI.
  • If you are under 25 years of age and received the property on which the income was received as a consequence of the death of any person and you are either eligible for the disability tax credit or a full-time, post-secondary student, the income is not SI.
  • If the property on which the income was received was acquired as part of a matrimonial settlement, the income is not SI.
  • If the income is a capital gain resulting from a deemed disposition on the death of the person, the income is not SI.
  • If you are 18 or older, the income is a capital gain from a sale to an unrelated person and the shares sold were qualified farm or fishing property or qualified small business corporation shares, the income is not SI.
  • If your spouse is 65 or older and the income would not be SI if your spouse had received it because they meet one of the exceptions, the income is not SI. Note that this continues to apply if the spouse is deceased.
  • If the income is within the requirements to be treated as a safe harbor capital return (essentially the prescribed rate of interest which is currently 2 per cent times the value of contributions that person has made to the business) this portion of the income is not SI.
  • If the income is considered to be a reasonable return in respect of work performed for the business, property contributed to the business, risks assumed and payments already received, the reasonable portion is not SI.

Determining how and whether these exceptions apply may require the involvement of your tax advisor.  If you are in receipt of income that could be classified as split income, contact your Collins Barrow advisor to ensure that you avoid the higher taxes that travelling on the TOSI highway will cost you.

Take the express! Try out our quick and friendly TOSI quiz to see if you're speeding towards tax on split income.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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