Revised Draft Legislative Proposals released on December 13, 2017
Starting January 1, 2018, ‘simpler rules’ will exclude certain individuals from having to meet a previously announced “reasonableness test” to determine whether income received will have a special “tax on split income” (“TOSI”)
What is the TOSI?
A special ‘tax on split income’ (TOSI), set out in section 120.4 of the Income Tax Act, was introduced in 1999 to address sprinkling of certain income to minor children (i.e., individuals under the age of 18 years). The rules apply to income from private business arrangements, such as dividends on unlisted shares, or income in the form of a trust or partnership distribution derived from a business or rental activity of a related individual. The TOSI also denies access to the lifetime capital gains exemption in respect of the disposition of shares as part of a non-arm’s-length transaction.
In cases where the TOSI applies, the income is subject to top flat-rate personal income taxation in the hands of the minor, and personal tax credits (with the exception of the dividend tax credit and foreign tax credit) are denied with respect to the amounts.
What are the simplified application?
- Exclusion from the application of the TOSI for specified adult individuals, including those aged 18 to 24, who contribute labor to a related business on a regular, continuous and substantial basis; An individual who works an average of 20 hours per week during the part of the year that a business operates will be deemed to be actively engaged on a regular, continuous and substantial basis for the year.
- Exclusion from the application of the TOSI for specified adult individuals over the age of 24 who have a significant equity investment in a corporation, other than a corporation that carries on a services business or that is a professional corporation;
- Simplification and clarification of the reasonableness test; Reasonable amount that are relevant to this analysis include labour contributions, capital contributions, risks assumed, as well as any other relevant factors. What constitutes a reasonable return is also determined with regard to previous amounts received from the business.
- Relief for spouses that is better aligned with the pension income splitting rules; TOSI rules will not apply to income received by an individual from a related business if the individual’s spouse made the contributions to the business and has attained the age of 65 years in or before the year the amounts are received.
- Changes to the treatment of capital gains to ensure that the TOSI rules do not limit access to the lifetime capital gains exemption;
Will CRA know?
Business owners who sprinkle income will need to proof that they meet the requirements. CRA may audit the owners’ books and records.
According to CRA, records such as timesheets, schedules or logbooks retained by either an individual or a business will be sufficient to establish the number of hours the individual worked in a given year. Where the individual also receives a salary or wages from the business, the CRA would also consider information contained in payroll records that supports the number of hours the individual worked.
TOSI will not apply to reasonable salary paid to family members.
New rules will start in January 1 2018, so business owners may do some planning before the end of 2017, and have a full year to get on-side, for example, 10% equity test for non-service businesses.