On December 13, 2017 the federal government released legislation with the intent to simplify the income sprinkling rules (referred to as the Tax On Split Income or TOSI) previously released on July 18, 2017. The intention of the legislation is to prevent the allocation of income to family members who are not involved in a business. The new legislation came into effect on January 1, 2018.
Changes to the TOSI rules
The previous TOSI rules:
- Only applied to individuals who were under 18 years old, having a Canadian resident parent.
- Included dividends from a private company and income from a partnership or trust that is derived from a business, profession or rental activity of a related person.
- Treated split income earned by a minor child (provided it is not otherwise subject to the income attribution rules) as subject to tax at the highest marginal rate. This achieves the same effective result as if the income was attributed back to the child’s higher income earning parent.
The new TOSI rules will go beyond the former TOSI rules, to also:
- Extend to all Canadian resident individuals, regardless of their age.
- Expand the type of split income to now include:
- Interest on loans to private corporations, partnerships or trusts.
- Gains from the disposition of shares or distributed through a trust, if the income on such shares would be split income.
Like its predecessor, the new TOSI rules do not apply to salaries paid to family members for work performed. The litmus test for a salary paid to a family member is whether it is deemed reasonable in relation to the services rendered. If the salary is deemed unreasonable, then the unreasonable portion of the salary paid will not be deductible for income tax purposes, albeit that the full amount of the salary received will be taxable to the family member.
When do the new TOSI rules apply?
To be subject to the new TOSI rules, a specified individual must be related to a source individual who is connected to a related business.
A specified individual is a Canadian resident at the end of the calendar year, or immediately before death if the individual passed away in the year. If the individual is under the age of 18 before the end of the calendar year, that individual will be considered a specified individual if s/he had a parent resident in Canada at any time during the year.
A source individual is an individual who, at any time in the year, is a Canadian resident and is related for income tax purposes to the specified individual.
A related business means:
- A business carried on by the source individual, or a business of a corporation, partnership or trust where the source individual is actively engaged on a regular basis in its business activities;
- A business of a partnership, where the source individual has an interest, directly or indirectly through one or more partnerships, in the partnership; or
- A business of a corporation, where the source individual owns at least 10% of the total fair market value of the corporation.
What are the exceptions to the TOSI rules?
Because the TOSI rules are so broad, the recently released legislation contains far more content dealing with when the TOSI rules do not apply, rather than the converse. When a source of income, or taxable capital gain from the disposition of property, is exempted from the TOSI rules, it is referred to as an excluded amount.
The following are the situations when a source of income or taxable capital gain constitutes an excluded amount:
- It arose in four unique situations.
- It is received from an excluded business.
- Where the specified individual is 25 years of age or older in the particular year, it is derived from excluded shares, or the amount does not exceed a reasonable return in respect of the individual.
- Where the specified individual is at least 18 years old, and did not reach age 25 in the particular year, the amount does not exceed a safe-harbour capital return, or the amount does not exceed a reasonable return having regard only to contributions of arm’s-length capital by the individual.
- Where the specified individual has a spouse aged 65 or over and certain other conditions are satisfied.
In part two of this series, we will take a closer look at the first two exceptions under which a source of income or taxable capital gain constitutes an excluded amount. In part three of this series, we will examine the last three exceptions, and share a flowchart that demonstrates how and if these new rules will apply to your family.
For more information on how the new TOSI legislation affects your specific case, reach out to your Zeifmans advisor today by calling 416.256.4000, or e-mail Nathan Choran, Tax Partner, at email@example.com.