Ocean Mist

Posted by Tax Consultants

Tax on Split Income (TOSI)

Canada’s Finance Minister Bill Morneau, On 13 December 2017,  released new draft legislation relating to income sprinkling. The new draft legislative proposals will extend the Tax on Split Income (TOSI) to individuals aged 18 and over. The proposals generally take effect 1 January 2018..

 

Minors

 

Any income or gains meeting the definition of “split income” will be subject to TOSI (with the exception described above on capital gains realized from direct or indirect dispositions of QSBC shares). Unless property has been inherited as a consequence of the death of a parent.

 

Individuals age 18 to 24 (returns on capital contributed)

 

Income on capital contributed to a related entity, for example shares, debt or a partnership interest, can be paid to the individual but must be limited to the prescribed rate of interest (currently 1%).

 

A higher than prescribed rate of return can be paid on capital contributed to a related entity; however, it must be reasonable, taking into account certain interpretive and judgmental factors, and must be from “arm’s length capital.” Generally speaking, the only source of arm’s length capital will be from earnings or gains associated with nonrelated sources. The arm’s length capital test precludes the individual from using loans or indebtedness (regardless if the borrowing is from an arm’s length source such as a bank), property acquired directly or indirectly from a related person, and earnings or gains generated from a related business.

 

Individuals age 18+

 

To the extent the individual is actively engaged on a regular, continuous and substantial basis in either the current year, or any cumulative five prior years, income generated from the business can be paid to the individual without the application of TOSI. As discussed above, it is a question of fact whether the individual is working a sufficient amount to meet this test, but they will be deemed to meet the test if they work an average of 20 hours per week while the business is operating. Once the five years of active/regular work threshold has been met (regardless of whether the years are consecutive), there are no TOSI restrictions on receipt of income by the individual. It should be noted that this exclusion will not apply to restrict TOSI on direct or indirect capital gains realized by the individual on property connected with the business.

 

Individuals age 25+

 

Income or gains can be realized by the individual to the extent it is a reasonable return from the related business, taking into account judgmental factors such labor efforts, capital contributed, risks taken, other payments already received from the business, and other factors that may be deemed relevant. There is no requirement that the capital contributed by the individual be from an arm’s length source. • Income or gains can be realized by the individual to the extent they are from “excluded shares,” regardless of whether the individual is active (or not) in the related business. As discussed in “Unanswered questions” below, the required criteria to meet the excluded share definition may have unintended consequences or ambiguous outcomes that will preclude access to the TOSI exclusion. The requirements for excluded shares are that: −The individual directly owns shares carrying 10% of the votes and value of the corporation −The business income of the corporation is derived less than 90% from the provisions of services −The corporation is not a professional corporation −All or substantially all of the income of the corporation for the particular year is not derived directly or indirectly from one or more other related businesses.

 

 Individuals age 65+

 

To the extent an amount of income, profit or gain would not be subject to TOSI in the hands of a spouse aged 65 or older, the other spouse may receive income from the related business independently of any TOSI exclusions. This rule is intended to align the TOSI rules with existing pension income splitting legislation.