CRA confirms that start-up risk that has now been eliminated can be taken into account in applying the TOSI reasonable return exception
Mr. and Mrs. X (both over 25) incorporate XCo, subscribe a nominal amount for non-voting and voting common shares, respectively and lend the proceeds of a mortgage on their home to XCo as start-up capital (the “Loan”). Mr. X has no involvement in XCo’s business, which is highly speculative. Several years later, XCo repaid the Loan and they repaid the mortgage.
Notwithstanding such repayment, can Mr. X continue to look to the reasonable return exception under the split income rules in s. 120.4 having regard to the risks he initially assumed on the start-up of XCo’s business? CRA stated:
If the terms and conditions of the Loan were not sufficient to adequately compensate Mr. X and Mrs. X for the risk they assumed when mortgaging their home and providing the Loan to XCo, the relative risk that was assumed by each of them in mortgaging their home and providing the Loan could be taken into account in determining whether a dividend received by Mr. X after the repayment of the Loan is a reasonable return in respect of Mr. X (among the other factors noted above). (emphasis added)
More generally, CRA stated that it “does not intend to generally substitute its judgment of what would be considered a reasonable amount where the taxpayers have made a good faith attempt to do so.”
Neal Armstrong. Summary of 2 November 2018 External T.I. 2018-0771851E5 under s. 120.4(1) – reasonable return.