Income splitting is a tax strategy that can be used by high-income owners of private corporations to divert their income to family members with lower personal tax rates.
Previously, the TOSI (“tax split on income”) rules applied the highest marginal tax rate (currently 33%) to “split income” of an individual under the age of 18 – this to prevent individuals from using their children to limit tax liability.
However, in January 2018, the federal government expanded the TOSI rules to include adult family members. The purpose of the expanded TOSI rules is to limit the tax benefits of income splitting where the related family member receiving the income has not made significant contributions to the business. Essentially, in the professional corporation context, dividends paid to all family members are taxed at the highest individual tax rate unless the dividend falls within one of the relevant exclusions:
- For adult individuals – amounts received from an excluded business (“Excluded Business”):
- Excluded business: amounts derived from a Related Business where the individual was actively engaged on a regular, continuous and substantial basis (“Actively Engaged”) in the activities of the business in the taxation year or in any five prior taxation years of the individual.
An individual will be deemed to be Actively Engaged if the individual works in the business at least an average of 20 hours per week during the portion of the taxation year of the individual that the business operates, or meets that requirement for any five prior years. The five taxation years need not be consecutive. In any other case, whether an individual is Actively Engaged will depend on the facts and circumstances of that case.
- For individuals age 25 or over – income from or taxable capital gain from the disposition of excluded shares (“Excluded Shares”) or a payment that qualifies as a reasonable return (“Reasonable Return”):
- Excluded Shares: shares of a corporation owned by an individual are excluded shares where:
- less than 90% of the corporation’s business income was from the provision of services and the corporation is not a professional corporation;
- the shares represent 10% or more of the votes and value of the corporation; and
- all or substantially all of the income of the corporation is not derived from another Related Business in respect of the individual other than a business of the corporation, and
- Reasonable return: payments that represent a reasonable return based on the following criteria (the “Reasonableness Criteria”):
- the work performed in support of the Related Business;
- the property contributed directly or indirectly in support of the Related Business;
- the risks assumed in respect of the Related Business;
- the total amounts paid or payable by any person or partnership to or for the benefit of the individual in respect of the Related Business; and
- such other factors that may be relevant.
- For individuals between the age of 18 and 24 – Return on property contributed in support of a Related Business that is a safe harbour capital return (“Safe Harbour Capital Return”) or a Reasonable Return having regard only to contributions of arm’s length capital to the business (“Arm’s Length Capital”):
- Safe Harbour Capital Return: Return on property contributed by the individual in support of the Related Business provided that such return does not exceed a prescribed capital return determined by formula, and
- Arm’s Length Capital: property of an individual, other than property that is derived from property income in respect of a Related Business, that is borrowed under a loan, or that is transferred from a related person (other than inherited property).
- For any individual – taxable capital gains realized on death or from the disposition of qualified farm or fishing property and qualified small business corporation shares.