CRA indicates that the returns to a spouse and older children from a Holdco in which they reinvested their Opco capital gains exemption could qualify as TOSI excluded amounts

A family trust (“Trust”) distributed the taxable portion of its gain on the sale of qualified small business corporation shares (of Opco) to its beneficiaries (Mr. and Mrs. X, and their children. Child X and Y, aged 15 and 22) who claimed the s. 110.6 deduction. The beneficiaries then used their sales proceeds to subscribe for the shares of a newly-incorporated holding company (Holdco): Trust – 50% of the Holdco shares; Mr. and Mrs. X – 20% each; and Child X and Y – 5% each). Holdco generated $150,000 from investing these funds in the stock market and paid a $100,000 dividend pro rata to its shareholders with Trust, in turn, distributing its $50,000 dividend to Mrs. X and Child X and Y.

In considering the split income rules, CRA indicated:

• The dividend paid by Holdco to Child X clearly would be added to the child’s split income given the age of under 17.
• If Holdco did not carry on a business, then the dividends received from Holdco would be “excluded amounts” for Mr. X, Mrs. X and Child Y because they were not derived from a business and, thus, not from a related business.
• If Holdco instead was carrying on a business (of earning income from the stock market) and, thus, a related business respecting Mr. X, Mrs. X and Child Y, the shares of Mr. and Mrs. X would be excluded shares given that they had the greater than 10% shareholdings in Holdco, Holdco’s income was not from property and substantially all of its income was from its own business. However, Child Y would not hold excluded shares given a shareholding of only 5%.
• Child Y could not benefit from the exclusion for arm’s length capital contributions provided in s. (f)(ii) of the "excluded amount" definition given that the capital subscribed for Holdco shares came from a taxable capital gain from the disposition of property which directly or indirectly came from a related business (i.e., the shares of Opco). This would only leave the “safe harbour capital return” exclusion for receiving the highest prescribed rate on the amount subscribed.
• A similar analysis applied to the distribution by Trust.

Neal Armstrong. Summaries of 5 October 2018 APFF Roundtable, Q.13 under s. 120.4(1) – excluded shares, excluded amount – (e)(i) and arm’s length capital.