TOSI & Passive Income Update

Taxation on Split Income & Passive Investment Income rules for Private Companies.

Internal Tax Advisory experts Bill Wiebe & Vern Peters highlight the issues that you need to know about…because it may have a significant impact on you.  We’ve included the following information to help you determine if either of these new taxation items are applicable in your situation.  More importantly, we want you to know that your Stark & Marsh advisors are available to help you navigate through the complexity.

Tax on Split Income (TOSI)

The new TOSI rules are effective starting in calendar 2018 and are intended to curb income splitting within family groups using private corporations. Income splitting is the technique of utilizing the lower income brackets of various family members, such as spouses or sons and daughters, often done by paying dividends to those individuals rather then just having the primary business operator reporting those dividends.

Some amounts continue to be exempt;

  • Wages paid to family members are not subject to TOSI although they continue to have to be a reasonable amount based on the circumstances.
  • Taxable capital gains from the disposition of qualified farm property, which includes farm land and family farm corporation shares, or qualified small business corporation shares are not subject to TOSI, although some amounts for individuals under age 18 will be.

While the new rules target various types of income from private corporations, most of our clients will need to be most concerned about dividends.

TOSI used to apply only to under age 18 individuals but can now apply to amounts received by both minor and adult individuals from a “related business”, subject to certain exclusions. Income caught under these rules is taxed at the top personal marginal rate of tax, which is 48% in Saskatchewan, with very limited deductions or credits. This often results in significantly higher income tax amounts than if the primary business operator reported all of the dividends rather than splitting them.

A related business includes a business carried on by someone related to you, or by a corporation,  partnership, or trust if a related person is actively engaged in the business, and a business of a corporation or partnership where a related person has a direct or indirect interest (10% or more of the fair market value of the shares in case of a corporation), such as a family operating company. 

There are several notable exceptions to the TOSI rules including:

  • You're 18 or over and you have been regularly engaged in the business' activities on a regular, continuous and substantial basis during the year or in any five previous years (the “excluded business” exception). These five years do not have to be consecutive. You can meet this test if you work an average of at least 20 hours per week in the business during the relevant years. 
  • You're 25 or over and you own 10% or more of the votes and fair market value of the corporation (the “excluded shares” exception – see Note 1 below). This corporation must also earn less than 90% of its income from providing services and cannot be a professional corporation such as one operated by an accountant, lawyer, dentist or doctor. Also, the corporation cannot derive more than 10% of its income from other related businesses.
  • Your spouse is 65 or older (the “age 65” exception) and the income would not be subject to the TOSI had it been received by the spouse.
  • Even if you don’t meet any of the preceding exceptions, there are also some other exceptions, however they are usually harder to meet, and include:
    • If you are 25 or over and the amount you receive is considered a "reasonable return" on your contributions to the business.
    • If you are 18-24 years old and you have contributed your own capital to the business, you may be allowed a prescribed rate of return or a reasonable rate of return on that capital contribution.
    • Income from property inherited by individuals under age 25 from a deceased parent (or from any deceased person if the individual under age 25 is a full-time student or claims a disability tax credit).
    • Income from property transferred on a breakdown of a marriage or common-law partnership.

The TOSI rules are very complex and what is adding to the problem is that the legislation uses a number of terms that are not defined, for example what is meant by business income?, is investment or rental activities considered business? and what is meant by services for the purposes of these rules ?, We will use our professional judgement when analyzing a situation keeping in mind the risk tolerance of our clients.

Note 1 - Excluded shares exception
This exception requires a direct shareholding by the individual so if a family trust owns shares of a private corporation, the excluded shares exception will generally not be available to individual beneficiaries of the trust.

When family members own shares of a holding company that derives income from a related business (e.g., an operating company owned by the holding company), the CRA’s current position is that the excluded shares exception will also generally not be available.

In some client situations, the corporation and/or trust can be restructured so that the excluded shares exception can be met.

Please contact your Stark & Marsh advisor if you would like to see if the TOSI rules will apply in your situation. If the rules do apply, Stark & Marsh can determine if a restructuring would be warranted or if other income splitting measures may be effective.

Passive investment income rules for private companies

Effective for taxation years that begin after 2018, there will be changes to a corporation’s small business limit where a corporation in an associated group earns passive investment income.  The small business limit can be phased out if the corporation or any associated corporations earn income from passive investments. A corporation, together with associated corporations, can earn up to $50,000 in passive investment income per year without affecting its small business limit. The small business limit will however be reduced by $5 for every $1 of investment income above the $50,000 threshold. The small business limit will be totally eliminated when the combined investment income of your corporation and associated corporations for the taxation years that ended in the preceding calendar year is $150,000 or more. So, although the grind begins after 2018, the 2018 income amounts will determine if there will be a grind in the first year after 2018.

For this purpose, a corporation's passive investment income includes, in general; rental income, royalty income, interest income, capital gains, dividends from non-connected corporations and income from savings in certain life insurance policies, but excludes taxable capital gains (and allowable capital losses) from the sale of active assets and investment income that is considered incidental to the business. 

There are anti-avoidance rules that can cause corporations to be associated for these rules if certain transactions are done to try and reduce the impact of the grind.

Part of the existing passive investment taxation measures includes the payment of refundable taxes which can be recovered when paying sufficient dividends to shareholders. There are now new measures to limit certain tax planning that private corporations used to access those refundable taxes on the distribution of eligible dividends.

Contact your Stark & Marsh advisor to determine how these new rules may affect your corporation. There is some planning that can be done to mitigate the affect of these new rules.

The information in this letter is current as of November 29, 2018.
This communication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The letter cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact Stark & Marsh CPA LLP to discuss these matters in the context of your particular circumstances.

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