Canada: A New Era Of Private Corporation Tax Rules – Part V

It has been just over a year since the federal Department of Finance ("Finance") released revised draft amendments to the tax on split income ("TOSI") rules in section 120.4 of the Income Tax Act (Canada) (the "Act") that "simplified" the original proposed amendments that were released in July 2017. Minor changes were subsequently made prior to the amendments receiving Royal Assent on June 21, 2018.

This is the fifth article in a series of articles discussing the TOSI rules. Part I discussed the types of income that TOSI applies to and some of the exceptions. Part II discussed the remaining exceptions to the general rule. Part III focused on clarifications to the "excluded shares" exception and discussed the use of family trusts in this new TOSI landscape. Part IV highlighted comments from the Canada Revenue Agency ("CRA") and Finance made during the roundtable at the CALU and STEP conferences earlier this year. This article discusses the application of the TOSI rules to investment income earned by a corporation after the underlying business is wound down or sold.

TOSI Rules Refresher

Income that is considered "split income" will be subject to the TOSI rules unless the amount is considered to be an "excluded amount". Taxable dividends, other than from public companies or mutual fund corporations, are included in the definition of "split income". While there are many "excluded amount" categories, this article will limit its discussion to the potential application of the "excluded shares" and "unrelated business" exceptions to dividends received from private corporations.

If an individual is 18 years old or older, then income that is not from a "related business" is considered an "excluded amount" and not subject to TOSI. Generally, a related business is a business that is carried on by a related person (such as a parent, spouse, or child) directly or indirectly through a partnership, corporation, or trust. A "related business" is also a business where a related person has an interest in a partnership or holds a certain interest in a corporation that carries on the business.

If an individual is 25 years or older, then income from an "excluded share" is considered an "excluded amount" and not subject to TOSI. For a share to be considered an "excluded share" of an individual, several conditions must be satisfied. Excluded shares are shares of a corporation that are owned directly by the individual (cannot be beneficially owned through a trust) and that satisfy the following conditions:

(i) less than 90% of the business income of the corporation is from the provisions of services (the "Services Test");

(ii) the corporation is not a professional corporation;

(iii) all classes of shares held by the individual collectively represent 10% or more of the votes that can be cast at an annual meeting of the shareholders of the corporation and 10% or more of the fair market value of all of the issued and outstanding shares of the capital stock of the corporation (the "Votes and Value Test"); and

(iv) all or substantially all of the income of the corporation is income that is not derived from a related business (the "Related Income Test").

The actual application of the TOSI rules depends on the particular facts and circumstances of each situation. In this Article, we will review the application of the TOSI rules in the context of income earned after the sale or windup of an operating business.

Scenario A: Selling or winding up of an operating business

Consider the following example. Diane is a landscape architect. Her corporation, Green Door Enterprises Ltd. ("Green Door"), carried on a landscaping business that designed indoor and outdoor common spaces for new commercial buildings. She and her husband, Derek, each own 50 voting common shares in the share capital of Green Door, which were issued for $1.00 each. Derek never contributed any capital to the business and never worked in the business. No other shares have been issued. Diane and Derek are both 55 years old.

Two years ago, Green Door sold all of its assets to one of their employees and ceased carrying on business. Green Door's retained earnings and the proceeds from the asset sale were invested in real estate and a stock portfolio. Investment income earned by Green Door is distributed to Diane and Derek equally in the form of a dividend. Is the dividend subject to TOSI?

One concern with a corporation only earning investment income is that the corporation does not earn any business income and that the Services Test is not met. This concern stems from comments made by the CRA at the 2018 STEP Roundtable. Fortunately, at the 2018 CTF National Conference Roundtable, the CRA clarified that if the investment activities constituted a "business", then the "Services Test" is likely met. Jurisprudence has established that only a limited amount of activity is required to constitute a business.

This response is consistent with Example 3 in the Technical Backgrounder on Measures to Address Income Sprinkling released by Finance in December 2017. In that example, two sisters owned 50% of the common shares of a corporation that earned only investment income. The source of the capital was the proceeds of a sale of land from their father. Finance commented that the shares held by the sisters would be considered "excluded shares" and dividend income would not be subject to TOSI.

This response is also consistent with Example 8 in the Guidance on the Application of the Split Income Rules for Adults released by the CRA in December. In Example 8, two siblings each owned 50% of the common shares of a corporation and were involved full time in the management and operations of the business of that corporation. The business was wound down and the corporation only owned a portfolio of passive investments that required sporadic management decisions and investment activity. One sibling passed away and their spouse inherited their shares. The CRA commented that a dividend paid to the shares held by the two shareholders would qualify as "excluded shares" and dividend income would not be subject to TOSI.

What if the investment activity of Green Door does not constitute a "business"? Consistent with Question 7 at the 2018 CRA STEP Roundtable, the CRA commented at the 2018 CTF National Conference Roundtable that if a corporation does not carry on a business, then the Services Test would not be satisfied. However, the CRA commented at the 2018 APFF and CTF National Conferences that if the corporation no longer carried on the business in the current year, the investment income would not be derived from a "related business" and dividend income would not be subject to TOSI.

If Green Door no longer carries on the landscaping business and only earns investment income, then dividends received by Diane and Derek may not be subject to TOSI. If the investment activity constitutes a business, then the Services Test is likely met and, if all the other conditions are satisfied, the shares held by Diane and Derek may be considered "excluded shares" and dividend income will not be subject to TOSI. If the investment activity does not constitute a business, then dividend income may be considered income that is not derived from a "related business" and also not subject to TOSI. The comments made by the CRA are welcome news and hopefully will create some certainty when an operating business ceases operations and historical retained earnings (and sales proceeds if any) are invested within the corporation.

Scenario B: Selling or winding up of business carried on by subsidiary

Consider instead, for example, a situation where Green Door is a wholly owned subsidiary of Green Door Holdings Ltd. ("Holdings"), which is owned by Diane and Derek. For creditor proofing and other purposes, retained earnings of Green Door were distributed to Holdings and invested by Holdings. Similar to Scenario A, Green Door sells all of its assets and the proceeds are invested by Green Door. The investment income earned by Green Door is distributed to Holdings and then to Diane and Derek.

In Scenario B, the income earned by Holdings is derived from both its own investment portfolio and dividends received from Green Door. If all or substantially all of Holding's income is from Green Door, then the Related Income Test may not be satisfied and the shares of Holdings may not be considered "excluded shares". However, if all or substantially all of Holding's income is not from Green Door, then the Related Income Test may be satisfied and the shares of Holdings may be considered "excluded shares" and dividends received by Diane and Derek not subject to TOSI. Whether or not Green Door or Holdings, or both, are carrying on a business will also be relevant factors in determining whether dividends earned by Diane and Derek are subject to TOSI.

In situations similar to Scenario B, where an underlying operating corporation is wound down or its assets are sold, consider combining the operating and holding corporations by way of amalgamation or wind-up and holding investments in the single remaining entity. This would avoid the potential to be offside the Related Income Test and, as there may no longer be a need to creditor proof, combining the two corporations would decrease ongoing compliance costs.


Whether dividends earned from a private corporation are considered an "excluded amount" in respect of a particular individual shareholder may differ from shareholder to shareholder of the same corporation and may differ with respect to the same shareholder as their circumstances change. The analysis may also vary from year to year if there is parent – subsidiary structure in place. Private corporations and individual shareholders should review the application of the TOSI rules prior to declaring a dividend.

The TOSI rules came into effect as of January 1, 2018. However, corporations have until the end of 2018 to complete corporate reorganizations to meet the "votes and value" test for shares to be considered "excluded shares", assuming all other conditions are satisfied.

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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William J. Fowlis
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