3 December 2018 CPA Canada Roundtable, 2018-0773811C6 - Tax on Split Income (TOSI)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

PRINCIPAL ISSUES: English and French versions of the PowerPoint presentation prepared for the CPA Canada Income Tax for the General Practitioner Course.

POSITION: See below.

REASONS: See below.

PowerPoint Slides

English slides

French slides

Rough Transcript (for search engine visibility)

• TOSI FOR ADULTS
• CRA Presentation to CPA Canada
• AGENDA
• Legislative History
• Basics of old Section 120.4
• Overview of Amendments to Section 120.4
• New Exclusions from TOSI: Safe Harbours & Other Excluded Amounts
• Key Changes
• Interpretive Issues
• 2017 Guidance
• Conference Positions
• Compliance Matters

• Disclaimer
• The material is for informational purposes only and should not be considered tax advice. Any amendments to the law or relevant court decisions occurring after the publication date will not have been considered in the preparation of the information unless otherwise specified.

• TOSI - Legislative Timeline
• July 18, 2017 - Tax Planning Using Private Corporations consultation paper including draft legislation
• October 2, 2017 – End of public consultation period
• October 2017 - Department of Finance Press Releases & Backgrounders
• December 13, 2017 – Simplified Measures to Address Income Sprinkling including revised Draft Legislation and Explanatory Notes
• March 20, 2018 - Bill C-74, Budget Implementation Act
• April 2018 – Department of Finance Explanatory Notes
• June 21, 2018 – Amended TOSI enacted into law, applicable after 2017

• Overview “Old” Section 120.4
  Kiddie Tax – Basic Framework

Subsections 120.4(2) & (3)

• Applies to “Specified Individuals”
• Taxes “Split Income” at top individual tax rate
• Tax reduced only by section 121 and 126 tax credits
• No reduction for other personal tax credits
• Underlying policy: restrict income splitting with minors

• Overview “Old” Section 120.4
  Kiddie Tax – Key Concepts

“Old” definition of “Specified Individual”

• An individual:
• Under age 18;
• Not non-resident of Canada; and
• Parent resident in Canada
• Overview “Old” Section 120.4
  Kiddie Tax – Key Concepts
• Under “old” definition, “Split Income” means:
• taxable dividends and section 15 benefits from private corporations
• allocations of partnership income:
• from property or services provided to business carried on by certain related persons
• Income from business or rental of property operated by related persons
• allocations from trust attributable to:
• taxable dividends and section 15 benefits from private corporations
• Income from property or services provided to business carried on by related persons
• Income from business or rental of property operated by related persons
• Split Income does not include “Excluded Amount”
• certain bequests received from parent; or by full time students or impaired individuals from any person
• Split Income does not cover wages and salary (but subject to section 67)
• Overview Amendments to Section 120.4
  “New” TOSI – Policy Background

• Government’s view that old Kiddie Tax did not sufficiently restrict all income splitting opportunities.
• Did not include adult children
• Did not include other related persons
• Overview Amendments to Section 120.4
  “New” TOSI - Policy

Example I: Income Sprinkling with Adult Specified Individual

Trust Distribution

Dividend

• Overview Amendments to Section 120.4
  “New” TOSI - Policy

Example I: Income Sprinkling with Adult Specified Individual

• Parent is taxed at the top personal tax rate
• Child is 18 years of age or over and a full-time university student
• Opco pays dividend to Family Trust
• Family Trust distributes dividend to Child (subsections 104(13) and (19)) to fund Child’s university fees and expenses
• Child can receive up to $51,635 of eligible dividends tax free (Based on 2017 Ontario tax rates & assuming no other income)
• Parent tax rate on same dividend – 39.34% (2018 Ontario tax rates)
• Overview Amendments to Section 120.4
  “New” TOSI: Key Changes

Summary of Key Changes:

• Retains basic frame work of “kiddie tax”
• Allows deduction from tax for disability tax credit (Section 118.3)
• Expands “Specified Individual” to cover any adult (age 18 or over) resident in Canada at end of year
• Expands definition of “Split Income”
• Adds:
• interest on certain debt issued by private corporations, partnership or trust (other than fully exempt interest, public debt, bank deposits; and
• taxable capital gains from property that generate split income
• Adds concept of a “Related Business” that generates Split Income
• Increases the categories of excluded amount not subject to TOSI
• Wage and salary still excluded

• Overview Amendments to Section 120.4
  New TOSI: Key Changes (Cont’d)
• Application of TOSI to Adult Specified Individual: Analytical Approach
• Is the taxpayer a Specified Individual?
• Yes, unless non-resident at end of year (or if year of death, before death)
• Is any amount of the taxpayer’s income Split Income?
• Yes, if income is private company dividends
• If other kind of income, check definition of Split Income (i.e. can cover partnership and trust allocations from related business & interest and taxable capital gains)*
• Is it an Excluded Amount from Split Income (and not subject to TOSI)?
• In most cases, will be the determining factor in whether TOSI applies
• Income may fall into more than one category of Excluded Amount
• If not Excluded Amount, TOSI applies

*Note: Refer to the CPA course materials for a more detailed discussion of the definition of “split income”

• Overview Amendments to Section 120.4
  Application

Example II: Income Sprinkling with Adult Specified Individual

Dividend

Note: Dividend is Split Income unless it is an excluded amount

• New TOSI
  Amended Definition - “Excluded Amount”

• Key Additions to “Excluded Amount”
• Generally apply based on age of the Specified Individual
• Income not derived directly or indirectly from a “Related Business” (Age 18 or over)
• Income derived directly or indirectly from “Excluded Business” (Age 18 or over)
• Income from a “Safe Harbour Capital Return” (Age 18 to 24)
• Income that is a “Arm’s Length Capital” “Reasonable Return” (Age 18 to 24)

• New TOSI
  Amended Definition – “Excluded Amount”
• Key Additions to Excluded Amount (Cont’d)
• Income or taxable capital gain from “Excluded Shares” (age 25 and over)
• Income that is a “Reasonable Return” (Age 25 and over)
• Special rule for Specified Individual whose spouse or common law partner is age 65 or over (Paragraph 120.4(1.1)(c))
• Taxable capital gains from “qualified small business corporation shares” and “family farm and fishing property”

• New TOSI
  Amended Definition “Excluded Amount”

• Other additions:*
• Income or taxable capital gains from property acquired on breakdown of marriage or common-law partnership
• Taxable capital gains on death
• Income or taxable capital gains from property acquired on certain bequests
• Retained from pre-amendment and extended to adult specified individuals but only up until age 24
• References to income “derived directly or indirectly” from a business
• Extended definition paragraph 120.4(1.1)(d)
• Example: Dividends are derived directly or indirectly from a business

*Note: Refer to CPA course materials for a more detailed discussion of the other additions to excluded amount

• “New” TOSI
  Amended Definition of “Excluded Amount”

General Comments

• Additions to Excluded Amount intended to simplify application of TOSI rules
• In case of certain exclusions, acts as proxy for straightforward situations which would otherwise satisfy the Reasonable Return test and do not raise any policy concerns
• Not intended to apply to all situations

• Key Additions to “Excluded Amount”
  No “Related Business”

Overview:

• Excluded Amount includes income that is not from a Related Business
• Not subject to TOSI
• Applies where “Specified Individual” age 18 or over
• Functions as basic exclusion from Split Income for adult Specified Individuals (i.e. Split Income does not include all dividends, but only dividends from Related Business)
• Will generally not be available in a family owned corporation or business
• Generally look to other categories of Excluded Amount

Note: Concept of “related business” also found in the definition of “split income” from a partnership, trust or proprietorship applicable to any specified individual. Refer to CPA course materials for a more detailed discussion of “related business” and split income

• Key Additions to “Excluded Amount”
  No “Related Business” (Cont’d)

Definition of Related Business

• Requirements in Subsection 120.4(1):
• “Business”
• “Source Individual”
• The “Source Individual” meets certain activity or ownership tests

• Key Additions to “Excluded Amount”
  No “Related Business” (Cont’d)

Definition of Related Business (Cont’d)

• Need a “Business”
• Extended definition in subsection 248(1):
• Includes an undertaking of any kind
• Includes an adventure or concern in the nature of trade
• Common law definition
• In general, any commercial activity carried on by a corporation should be a business
• But based on facts and circumstances of each case
• 2018 STEP CRA Roundtable, Ques. 7 & 2018 APFF CRA Roundtable Ques. 9
• Accepts possibility that a corporation may not carry on a business (& have no business income)
• Better to rely on another category of Excluded Amount?

• Key Additions to “Excluded Amount”
  No “Related Business” (Cont’d)

Definition of Related Business (Cont’d)

• Need a “Source Individual”
• Definition 120.4(1)
• Individual (other than trust)
• Resident in Canada
• Related to the Specified Individual
• Definition of “related” – paragraph 251(2)(a)
• i.e. parent, spouse, common-law partner, sibling, child
• Can include individual related by adoption (paragraph 251(6))
• Paragraph 120.4(1.1)(e) – spouse or common-law partner not related if living separate and apart because of breakdown of relationship

• Key Additions to “Excluded Amount”
  No “Related Business” (Cont’d)

Definition of Related Business (Cont’d)

• Source Individual Meets Participation or Ownership Tests
• Source Individual:
• carries on the business in the year; or
• is actively engaged on a regular and continuous basis in the activities of the partnership, trust or corporation that carries on the business in the year; or
• owns an interest in the entity that carries on the business
• If entity is a partnership, any direct or indirect interest; or
• If entity is a corporation, shares of the corporation or property that derive all or part of its FMV from such shares where FMV of shares or property (or part thereof) that is derived from such shares represent 10% or more of the FMV of all of the issued shares of the corporation

• Key Additions to “Excluded Amount”
  No “Related Business” (Cont’d)

Example III: Income not from a Related Business

Facts:

• A is a 40 year old Canadian resident and the majority shareholder of Opco
• Opco is a CCPC and a start-up established to develop gaming software
• B is a 20 year old Canadian resident computer engineering student and is employed part time to help develop the software
• B was issued 20% of the shares of Opco as part of his compensation
• A and B are not related
• Opco pays a dividend to B
• Key Additions to “Excluded Amount”
  No “Related Business” (Cont’d)

Example III: Income not from a Related Business (Cont’d)

Conclusion:

• Dividend is not subject to TOSI

Analysis:

• Is the income Split Income? Yes
• B is a Specified Individual
• Income is dividend on share of unlisted (private) corporation
• Is the income an Excluded Amount? Yes
• Not income from Related Business
• No “Source Individual”
• A is not related to B
• Not derived directly or indirectly from another Related Business
• No need to determine whether income is a Reasonable Return (or other Excluded Amount)

• Key Additions to “Excluded Amount”
  “Excluded Business”

Overview

• Excluded Amount includes income derived directly or indirectly from an “Excluded Business”
• Not subject to TOSI
• Applies to specified individuals age 18 and over
• Safe harbour added to simplify application of TOSI
• Based on bright-line test/more objective criteria
• If requirements met, not subject to TOSI regardless of amount of payment/avoids Reasonable Return test

• Key Additions to “Excluded Amount”
  “Excluded Business”

Definition of Excluded Business

• Requirements in Subsection 120.4(1)
• Specified individual is “actively engaged on a regular, continuous and substantial basis in the business” (“Actively Engaged”)
• in the taxation year the split income earned (other than Split Income that is taxable capital gain from unlisted shares or certain interests in a partnership or trust or income from certain debt obligations); or
• in any five prior taxation years (i.e. five years need not be consecutive)

• Key Additions to “Excluded Amount”
  “Excluded Business”

Definition of Excluded Business (Cont’d)

• Determination of whether specified individual satisfies Actively Engaged test based on either:
• Deeming rule – Paragraph 120.4(1.1)(a); or
• Facts and Circumstances Test

• Key Additions to “Excluded Amount”
  “Excluded Business”

Definition of Excluded Business (Cont’d)

• Meeting Actively Engaged Test:
• Deeming Rule – Paragraph 120.4(1.1)(a)
• Specified individual deemed to be Actively Engaged in a business if individual works in the business at least an average of 20 hours per week during the period of the year in which the business operates
• Bright line test to simplify application of TOSI
• 20 hour requirement need not be met throughout the taxation year (i.e. seasonal business)

• Key Additions to “Excluded Amount”
  “Excluded Business”

Definition of Excluded Business (Cont’d)

• Meeting Actively Engaged Test (Cont’d):
• Facts and Circumstances Test
• Specified Individual can be Actively Engaged in a business even if individual works on average less than 20 hour per week
• Based on a review of the facts and circumstances of the particular case

• Key Additions to “Excluded Amount”
  “Excluded Business”

Example IV: Excluded Business & Operating Period of the Business

Facts*:

• Farmco carries on an active farming business
• Farmco’s shareholders are Father, Mother and a Family Trust for Child 1 and Child 2
• Child 1 and Child 2 are both residents of Canada and over age 18
• Farmco carries on a seasonal farming business and only operates 40 weeks per year
• Child 1 worked 40 hours per week but only for 20 weeks during the year
• Child 2 worked at least 20 hours per week for the full 40 week period during the year
• Opco pays a dividend to Family Trust which is distributed by Family Trust to Child 1 and Child 2

*Based on Example 4A in Guidance on the application of the split income rules for adults

• Key Additions to “Excluded Amount
  “Excluded Business”

Example IV: Excluded Business (Cont’d)

Trust Distributions

Dividend

• Key Additions to “Excluded Amount”
  “Excluded Business”

Example IV: Excluded Business & Operating Period of the Business (Cont’d)

Conclusion:

Dividends received by Child 1 and Child 2 are not subject to TOSI

Analysis:

• Is the income Split Income? Yes
• Child 1 and Child 2 are Specified Individuals
• Income is dividend on unlisted (private corporation) shares
• Derived directly or indirectly from a Related Business
• Is the income in another category of Excluded Amount? Yes
• Dividend is derived directly or indirectly from an Excluded Business
• Child 1 and Child 2 deemed to be Actively Engaged in the business (i.e. work on average 20 hours per week during the 40 week period during which Farmco operates its business)
• No need to determine whether income is a Reasonable Return

• Key Additions to “Excluded Amount”
  “Excluded Business”

Example V: Excluded Business & Prior 5 Year Test

Facts:

• Same as Example IV except that during the year, Child 2 took the summer off and did not work on average 20 hours per week for the 40 weeks operating period of the business
• Child 2 has worked on average more than 20 hours per week for the last 6 of the last 7 years
• Child 2 receives the same dividend from Farmco for the year

• Key Additions to “Excluded Amount”
  “Excluded Business”

Example V: Excluded Business & Prior 5 Year Test (Cont’d)

Conclusion:

Dividends received by Child 2 are not subject to TOSI

Analysis:

• Is the income Split Income? Yes
• Child 2 is a specified individual
• Income is dividend on unlisted (private corporation) shares
• Derived directly or indirectly from a related business
• Is the income in another category of Excluded Amount? Yes
• Dividend is derived directly or indirectly from an “Excluded Business”
• Child 2 not deemed to be Actively Engaged in the business in the taxation year but met the test in any 5 prior taxation years
• No need to determine whether income is a Reasonable Return

• Key Additions to “Excluded Amount”
  “Excluded Business”

Example VI: Excluded Business & Multiple Businesses

Facts:*

• Spouse A owns non-voting preferred shares of Opco
• Spouse B owns all of the common shares of Opco
• Spouse A and Spouse B are Specified Individuals
• Opco carries on a construction business and a property management business
• Spouse A has worked on average more than 20 hours per week for the property management business since incorporation (last 10 years)
• Spouse A not Actively Engaged in the construction business
• Opco pays a dividend to Spouse A

*Based on example in correspondence from CRA to Canadian Federation of Independent Business dated May 25, 2018

• Key Additions to “Excluded Amount”
  “Excluded Business”

Example VI: Excluded Business & Multiple Business (Cont’d)

Conclusion:

Any dividends derived directly or indirectly from property management business are not subject to TOSI

Analysis:

• Is the income Split Income? Yes
• Spouse A is a specified individual
• Income is dividend on unlisted (private corporation) shares
• Derived directly or indirectly from a Related Business
• Is the income in another category of Excluded Amount? Yes, in the case of property management business
• Dividend is derived directly or indirectly from an “Excluded Business”
• Spouse A deemed to be Actively Engaged in the property management business in the taxation year (meets 20 hour test)
• Any dividend to Spouse A from construction business not from an Excluded Business
• Does another category of Excluded Amount apply?
• For example, is the dividend income from excluded shares?
• Tracking business from which dividend paid?

• Key Additions to “Excluded Amount”
  “Excluded Business”
  Multiple Businesses - Streaming
• Where dividends are derived from income earned in more than one business in a corporation – ensuring dividends paid to a specified individual are sourced from the business in which the individual is actively engaged
• Issues to consider
• Single vs separate businesses – paragraph 3 of IT206R
• Dividends paid annually as opposed to periodically
• Particular situations
• Loss businesses
• Large dividends exceeding earnings in recent years

• Key Additions to “Excluded Amount”
  “Excluded Business”

Compliance Issues

Audit Support for Satisfying 20 Hour Work Week

• Will depend on the facts and circumstances of the case
• Factors that may be looked at include:
• Timesheets, Schedules, Logbooks
• Payroll records
• Type of business and the duties performed as they relate to the main activities of the business
• The individual’s education, training and experience
• Particular knowledge, skills or know-how of the individual
• Key Additions to “Excluded Amount”
  “Excluded Business”
  Compliance Issues: Books and Records – Bright Line Test
• Test is meant to be objective
• Best way to document is to maintain records showing hours worked in the year for family members receiving dividends
• For those relying on test being met in 5 previous years, CRA recognizes that such records may not have been maintained or no longer exist.
• In such situations, the CRA will consider any available information related to the history of the business that is indicative of the degree of involvement of family members.
• We intend to be reasonable in evaluating situations where records may not be available for past years.

• Key Additions to “Excluded Amount”
  “Excluded Shares”

Overview

• Excluded amount includes income or taxable capital gains from “Excluded Shares”
• Not subject to TOSI
• Applies if specified individual age 25 and over
• Safe harbour added to simplify application of TOSI
• Based on bright-line test/more objective criteria
• If requirements met, not subject to TOSI regardless of amount of payment/avoids “Reasonable Return” test

• Key Additions to “Excluded Amount”
  “Excluded Shares:

Definition of Excluded Shares

• Definition in Subsection 120.4(1)
• Corporation not in service business;
• Specified individual meets ownership thresholds; and
• Corporation’s business not earning income from related business

• Key Additions to “Excluded Income”
  “Excluded Shares”

Definition of Excluded Shares (Cont’d)

• Not Service Business:
• Less than 90% of business income of the corporation for its prior taxation year was from the provision of services); and
• Not a professional corporation
• Notes:
• 2018 STEP CRA Roundtable – Question 5
• Reference to “income” is to gross income
• Whether income is from provision of services (or non-services) should be clear in most circumstances
• Where a single business involves provision of both service and non-services, must generally track each separately unless non-service is incidental
• Key Additions to “Excluded Income”
  “Excluded Shares”

Definition of Excluded Shares (Cont’d)

• Ownership Threshold:
• Specified individual must own shares of corporation representing:
• 10% or more of votes of all shares; and
• 10% or more of fair market value of all shares

Notes:

• Direct share ownership required (i.e. no “indirect” ownership through trust or partnership)
• Can restructure prior to 2018 to meet requirements for being Excluded Shares

• Key Additions to “Excluded Income”
  “Excluded Shares”

Definition of Excluded Shares (Cont’d)

• No Related Business:
• All or substantially all of the income of the corporation for the prior taxation year is not derived directly or indirectly from one or more other related businesses of the specified individual other than the business of the corporation
• Key Additions to “Excluded Income”
  “Excluded Shares”

Example VII: Excluded Shares

Facts:*

• Spouse A owns 50 Class A and Spouse B owns 50 Class B common shares of Opco
• Spouse A and Spouse B are both Canadian residents and over age 25
• Opco carries on an active business of supplying computer components to unrelated persons
• Spouse A works full time in Opco’s business
• Spouse B has no involvement of any kind in the operation of Opco’s business
• Opco pays a dividend to Spouse B

*Based on Example 3 in Guidance on the application of the split income rules for adults

• Key Additions to “Excluded Amount”
  “Excluded Shares”

Example VII: Excluded Shares (Cont’d)

Dividend

• Key Additions to “Excluded Income”
  “Excluded Shares”

Example VII: Excluded Shares (Cont’d)

Conclusion:

• Dividend received by Spouse B not subject to TOSI

Analysis:

• Is the income Split Income? Yes
• Spouse B is a Specified Individual
• Income is a dividend from unlisted (private corporation) shares
• Derived directly or indirectly from a Related Business
• Is the income in another category of Excluded Amount? Yes
• Dividend paid by Opco to Spouse B is on income from Excluded Shares
• Opco’s income not from services/not professional corporation
• Spouse B owns shares representing more than 10% of votes and value
• Opco’s income not from a related business
• No need to determine whether income is a Reasonable Return

• Key Additions to “Excluded Amount”
  “Excluded Shares” - Interpretive Issues

Example VIII: Excluded Shares and Holding Corporation

Facts:*

• Spouse A and Spouse B own 50% of the shares of Holdco
• Holdco owns all of the shares of Opco
• Holdco also owns investment assets that earn nominal income
• Spouse A and Spouse B are over age 25
• Spouse A is Actively Engaged in Opco’s business
• Spouse B has made no contribution to Opco’s business
• Opco pays a dividend to Holdco
• Holdco pays a dividend to Spouse A and Spouse B

*Based on 2018 STEP CRA Roundtable, Ques. 6

• Key Additions to “Excluded Amount”
  “Excluded Shares”- Interpretive Issues

Example VIII: Excluded Shares and Holding Corporations (Cont’d)

Dividends

Dividend

• Key Additions to “Excluded Amount”
  “Excluded Shares” - Interpretive Issues

Example VIII: Excluded Shares and Holding Corporation

Conclusion:

• Dividend received by Spouse B not income from Excluded Shares

Analysis:

• Is the income split income? Yes
• Spouse B is a Specified Individual
• Dividend on unlisted (private corporation) shares
• Derived directly or indirectly from a related business
• Is the income in another category of Excluded Amount?
• Not income from Excluded Shares
• In general, shares of a holding corporation will not qualify as excluded shares
• All or substantially all of Holdco’s income is derived directly or indirectly from a related business (i.e. Opco’s business)
• Does another category of Excluded Amount apply?
• If not, dividend is subject to TOSI

• Key Additions to “Excluded Amount”
  “Excluded Shares” - Interpretive Issues

Example IX: Excluded Shares and Income from Services

Facts:*

• Brother A owns shares representing 15% of votes and value of Transportco
• Brother B owns the remaining shares of Transportco
• Brother A and Brother B are specified individuals over age 25
• Transportco’s business is providing drivers on contract for logistic companies
• More than 90% of Transportco’s income is from that business
• Brother B is Actively Engaged in the business
• Transportco has over 100 employees
• Transportco pays a dividend to Brother A

*Based on 2018 CALU CRA Roundtable, Ques. 6

• Key Additions to “Excluded Amount”
  “Excluded Shares” - Interpretive Issues

Example IX: Excluded Shares and Income from Services

Conclusion:

• Dividend income of Brother A is not from Excluded Shares

Analysis:

• Is the income split income? Yes
• Brother A is a Specified Individual
• Dividend on unlisted (private corporation) shares
• Derived directly or indirectly from a Related Business
• Is the income in another category of Excluded Amount?
• Not income from Excluded Shares
• 90% or more of Transportco’s income is from the provision of services
• Does another category of Excluded Amount apply?
• If not, dividend is subject to TOSI

• Key Additions to “Excluded Amount”
  “Excluded Shares” - Interpretive Issues

Example X: Excluded Shares & Mixed Supply Business

Facts:*

• Pumberco operates plumbing business
• The business includes providing installation, repair and maintenance services and the supply of any related parts or equipment
• In the prior taxation year, 15% of Plumberco’s gross business income was from the provision of non-services
• Spouse A and Spouse B are equal (votes and value) shareholders of Plumberco
• Spouse A is the owner-manager of the business
• Spouse B is not Actively Engaged in the business and has never made any material contribution to the business
• Plumberco pays a dividend to Spouse B

*Based on 2018 STEP CRA Roundtable, Ques. 5

• Key Additions to “Excluded Amount”
  “Excluded Shares” - Interpretive Issues

Example X: Excluded Shares and Mixed Supply Business

Conclusion:

• Dividend to Spouse B is not subject to TOSI

Analysis:

• Is the income Split Income? Yes
• Spouse B is a Specified Individual
• Dividend on unlisted (private corporation) shares
• Derived directly or indirectly from a Related Business
• Is the income in another category of Excluded Amount? Yes
• The dividend is income from Excluded Shares
• Less than 90% of the business income is from the provision of services
• Spouse B owns more than 10% of the votes and value
• No income from another Related Business (other than Plumberco’s business)

• Key Additions to “Excluded Amount”
  “Excluded Shares” - Compliance Issues
  Mixed Service and Non-Service Businesses
• Gross revenue test
• Where goods are provided in combination with a service and the goods are not incidental – consider amount of revenue related to goods
• Eg. Auto repairs, home renovations
• Service can be incidental – eg. delivery and installation of goods sold
• CRA recognizes that billing practices and accounting systems may not specifically identify revenue from non-services – flexibility when reviewing such situations
• Key Additions to “Excluded Amount”
  “Reasonable Return”

Overview

• Excluded Amount includes income, the amount of which is a “Reasonable Return”
• Not subject to TOSI
• Different tests based on age of the specified individual
• “Safe Harbour Capital Return” (Age 18 to 24)
• “Arm’s Length Capital” “Reasonable Return” (Age 18 to 24)
• General “Reasonable Return” (Age 25 and over)

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Safe Harbour Capital Return

Overview

• One of the changes to simplify the application of the TOSI rules
• Applies where Specified Individual between age 18 and 24
• Provides a bright line exclusion from Split Income without having to establish whether amount of income is a Reasonable Return
• Amount determined by formula
• No Split Income to extent amount does not exceed a prescribed rate of return on FMV of property contributed by the Specified Individual in support of the Related Business

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Safe harbour capital return (Cont’d)

Formula in definition of “safe harbour capital return” in Subsection 120.4(1):

• Total of the amounts determined by:

A x (C x D/E)

• A = Highest Regulation 4301(c) prescribed rate for the year
• C = Initial FMV of each property contributed by specified individual in support of related business
• D = Number of days in year the property used in support of related business
• E = Number of days in the year

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Arm’s Length Capital Reasonable Return

Overview

• Excluded amount includes reasonable return having regard only to the contributions of arm’s length capital by the specified individual
• Not subject to TOSI
• Applies to specified individual between the age of 18 and 24
• In practice, applies if specified individual cannot rely on the safe harbour capital return
• Specified individual can have an amount of income from related business that exceeds the safe harbour capital return if such amount is a reasonable return but based only on the amount of “arm’s length capital” contributed

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Arm’s Length Capital Reasonable Return (Cont’d)

• “Arm’s length capital” of a specified individual
• Defined in subsection 120.4(1)
• Not Acquired as income, or taxable capital gain or profit, from another property that was derived directly or indirectly from a related business;
• Not Borrowed money; or
• Not Transferred directly or indirectly from a related person (other than as a result of death)

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Reasonable Return

Overview

• Excluded amount includes amount to the extent that is a Reasonable Return
• Not subject to TOSI
• Applies to specified individual age 25 or over
• Excluded amount of last resort – only if none of the other categories of excluded amount apply
• Key Additions to “Excluded Amount”
  “Reasonable Return”

Reasonable Return (Cont’d)

• Defined in subsection 120.4(1)
• Whether amount of split income of specified individual is reasonable measured by relative contributions of specified individual and source individual based on the following factors (“Reasonableness Criteria”):
• Labour Contribution: work performed by them for the related business
• Property Contribution: property contributed by them directly or indirectly in support of the related business
• Risks Incurred: the risk assumed by them in respect of the related business
• Historical Payment: total of all amounts paid or payable by any person or partnership to, or for the benefit of, them in respect of the related business
• Other Factors: such other factors as may be relevant

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Reasonable Return (Cont’d)

• Will depend on the facts and circumstances of each case
• Examples of factors to consider in applying Reasonableness Criteria in Guidance on the application of the split income rules for adults
• In general, the Canada Revenue Agency will not question what is a reasonable amount where the taxpayers have made a good faith attempt to determinate a Reasonable Return based on the facts and circumstances

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Labour Contribution

• The nature of the tasks performed
• Hours required to complete tasks
• A competitive salary/wage for tasks in relation to businesses of similar size and industry
• Education, training and experience
• Degree of activities and nature of activities in relation to those of business of a comparable nature and size
• Time spent on the activity in comparison to time spent in other activities or undertakings
• Particular knowledge, skill or know-how that the individual possessed
• Business acumen
• Past performance of functions

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Property Contribution

• The amount of capital contributed to the business
• The amount of loans to the business
• The FMV of property (tangible and intangible) transferred to the business, including technical knowledge, experience, skill, know-how
• Whether the individual has provided property as collateral for loans or other undertakings
• Whether other source of capital or loans are readily available
• Whether comparable property are readily available
• Whether property are unique or personal to the individual
• Opportunity costs
• Past property contributions

• Key Additions to “Excluded Amount”
  Reasonable Return

Risk Assumption

• Whether the individual is exposed to the financial liabilities of the business, whether through guarantees of mortgages, loans or lines of credit or otherwise
• Whether the individual is exposed to statutory liabilities related to the business
• Extent of the risk that contributions made by the individual to the business may be lost, whether in whole or part
• Whether any risk is indemnified or otherwise limited in the circumstances, whether by agreement or otherwise
• Whether the individual’s reputation or personal goodwill is at risk
• Past or ongoing risk assumption
• Key Additions to “Excluded Amount”
  Reasonable Return

Total Amounts Paid

• All payments of any kind
• Salary or other remuneration or compensation
• Dividends
• Interest
• Proceeds
• Fees
• Any benefit or deemed benefit of any kind

• Key Additions to “Excluded Amount”
  Reasonable Return

Example XI: Reasonable Return

Facts:*

• Professionalco carries on a professional practice business
• Spouse A and Spouse B own 50% of the shares of Professionalco
• Spouse A and Spouse B are specified individuals and over age 25
• Spouse A is a licensed professional and works full time in the business
• Spouse B on average works less than 20 hours per week doing bookkeeping
• Prior to marriage, bookkeeping was done by part-time arm’s length employee
• Professionalco pays a dividend to Spouse B
• The amount of the dividend approximates but is higher than the wages paid to the employee

*Guidance on the application of the split income rules for adults, Example 11

• Key Additions to “Excluded Amount”
  “Reasonable Return”

Example XI: Reasonable Return (Cont’d)

Conclusion:

• Dividend of Spouse B is not subject to TOSI

Analysis:

• Is the Dividend Split Income? Yes
• Spouse B is a Specified Individual
• Dividend on unlisted (private corporation) shares
• Derived directly or indirectly from Related Business

Is the income in another category of Excluded Amount? Yes

• Amount is a Reasonable Return based on Reasonableness Criteria
• Dividend high but comparable to wage paid to arm’s length employee
• Canada Revenue Agency will not substitute its own judgement where taxpayers have made good faith attempt to determine Reasonable Return

• Key Additions to “Excluded Amount”
  Special Application Rules

Subsection 120.4(1.1)

Special rules allow limited income sprinkling on property acquired from a deceased or by a spouse/common-law partner age 65 or over

• Allows an adult specified individual who acquires property as a result of the death of another individual to step in the shoes of the deceased in determining whether income from such property is a “reasonable return” or is from an “excluded business”
• Allows income or taxable capital gain of specified individuals to be deemed an excluded amount if it would have been an excluded amount if it was income of their deceased spouse or common-law partner
• Allows income or taxable capital gain of specified individuals to be deemed an excluded amount if it would have been an excluded amount if it was income of their spouse or common-law partner who is age 65 or over

• Key Additions to “Excluded Amount”
  Special Application Rules

Example XII: Income Sprinkling by Senior

Facts:*

• Spouse A and Spouse B own respectively 95% and 5% of the shares of Investco
• Spouse A is over age 65 and Spouse B is age 60
• Investco carried on an active business for over 25 years which has been wound down
• Investco owns and manages a portfolio of passive investment assets and carries on a business of earning income from property
• Spouse B never Actively Engaged and made no material contribution to Investco’s business
• Investco pays the net investment income to Spouse A and Spouse B

*Guidance on the application of the split income rules for adults, Example 12

• Key Additions to “Excluded Amount”
  Special Application Rules

Example XII: Income Sprinkling by Senior (Cont’d)

Conclusion:

• Dividend received by Spouse B is not subject to TOSI

Analysis:

Is the income split income? Yes

• Spouse B is a Specified Individual
• Income is dividend on unlisted (private corporation) shares
• Derived from a related business

Is the income in another category of Excluded Amount? Yes

• Investco shares are excluded shares of Spouse A
• Income would have been an excluded amount if income of Spouse A as income from excluded shares
• Income is excluded amount of Spouse B because it would have been an excluded amount of Spouse A

• Key Additions to “Excluded Amount”
  QSBC Shares and Farm & Fishing Property
• Taxable capital gain from “qualified small business corporation share” or “qualified farm and fishing property” is an excluded amount and not subject to TOSI
• “qualified small business corporation share” and “qualified farm and fishing property” defined in subsection 110.6(1)
• Preserves taxable capital gains splitting utilizing capital gains exemptions (See also Department of Finance Backgrounder Government Thanks Canadians for Helping Get Tax Fairness Right, October 17, 2017)
• Exception if taxable capital gain from dispositions described in subsections 120.4(4) or (5) (i.e. from non-arm’s length transfers)

Henry Chong

Jean Lafrenière

Reorganizations Division

Income Tax Rulings Directorate

Michael Warren

Manager, Technical Section

Domestic Compliance Programs Branch