TAX ON SPLIT INCOME (TOSI)

Tax on split income (TOSI) applies where a family member receives income from a related business in the motive of reducing taxes. In general, an individual's split income includes certain taxable dividends, taxable capital gains and income from partnerships or trusts.

By sprinkling income to other family members in lower tax bracket, the primary taxpayer will enjoy tax benefit by lowering the taxable income. TOSI rules will be applicable in these situations.

Example: a child is receiving dividends from the family company. If such income was determined subject to TOSI rules, it would be taxed at the highest marginal tax rate. The current highest marginal rate is 33%.

Starting on January 1, 2018, the Government of Canada introduced an expansion to the tax on split income rules. TOSI rules can now apply to related adults who have not made sufficient contributions to the business and any income received deemed to be subject to TOSI.

Exclusions:

1. Excluded Business:

TOSI rules can be avoided if a business owner's spouse or children (age 18 or older) are actively engaged in the business on a “regular, continuous and substantial basis'' with an average of 20 hours per week.

2. Excluded Shares:

Tosi rules can be avoided for income or capital gains from the disposition of shares held by individuals aged 25 or older.

To qualify as “excluded shares”, the individual must own at least 10% of both the voting shares and value of the company. 90% or less of the corporation’s business income must come from provision of services, and 90% or more of total income should not be received from related businesses.

3. Return on Safe Harbor Capital:

A family member is over the age of 25 and the income represents a reasonable return or safe harbor capital return on their investment.

4. Taxpayers with Spouses Aged 65 or Older:

This allows a senior business owner to split income with spouse, without worrying about the spouse’s level of involvement with the corporation’s business, or to be concerned about whether the corporate shares satisfy the excluded shares or reasonable return exceptions.

What is safe harbor capital return?

A return up to a prescribed interest rate based upon the FMV of property contributed by the specified individual in support of a related business. The highest prescribed interest rate in effect for a quarter in the year is to be used.

Example: If a child contributes $1,000 to his/her father's business in the beginning of the year and assume highest prescribed rate in any quarter for the year is 5%. The safe harbor capital return would be $50 ($1,000 x 5% x 365 days/365 days ). If the child's income from this investment does not exceed $50, TOSI does not apply.

The taxpayer must complete Form T1206 – Tax on Split Income to determine the TOSI-adjusted taxable income.

Conclusion

Income splitting is indeed a popular tax planning strategy followed by most business owners for a long time. However, it is crucial to understand the tax rules surrounding this strategy to avoid legal issues, unintended taxes and penalties.

TOSI rules and attribution rules are quite complex in nature. These are the primary rules relevant to income splitting. Therefore, it is recommended to consult professional tax advisors well in advance of planning and implementing these tax strategies.

For more information, please visit CRA at: Canada Revenue Agency