2 December 2019 CTF Conference - Paul Wilson in "New Taxation Rules for Private Corporations: So far, so reasonable?"

This provides abbreviated summaries of comments made by Paul Wilson (Director, Medium Business Audit Division, Small and Medium Enterprises Directorate (the "Directorate")) at the 2 December 2019 Annual Conference of the Canadian Tax Foundation in Montreal in the presentation "New Taxation Rules for Private Corporations: So far, so reasonable?". The other presenters, who also supplied the questions below, were David Stevens (Gowlings) and Justin Mastrangelo (BDO).

Guidance for Auditors


How are the field auditors instructed to address TOSI questions, including “reasonable return,” and what guidance do they have?


The auditors were instructed a few months ago to make mandatory referrals to Headquarters if they intend to propose or make an assessment relating to the post-2018 TOSI amendments. This will help to ensure consistency.

Job aids are being prepared for our auditors in an attempt to mechanize a lot of the elements in the application of the TOSI. The Directorate’s work has highlighted tax practitioners’ need for the Directorate to move beyond interpretations into what, specifically, it will do in a TOSI analysis, and what judgment points the auditors need to bring to bear in assessing or completing an audit efficiently. The Directorate also wishes to reduce the time needed for TOSI analysis.

The Directorate worked closely with Rulings to put together some of those examples that were posted in July, and will continue working with them – practitioners have raised areas where further examples are needed.

TOSI Examples

Scenario 1 - Corporate income derived from GIC

A corporation that holds $1 million of GIC’s is owned by 4 shareholders who are siblings. The shareholders vary in age between 30 and 55. The GIC’s are held for a one year term and renew automatically each year. The company earns $50,000 of interest income annually. The shareholders’ only involvement with the company is to meet once a year to decide on the quantum of dividends to be paid out to the shareholders in the fiscal year.

Are the activities of this corporation sufficient to constitute a business and if so, does the CRA consider this corporation to be earning business income for purposes of the TOSI rules?


This example has not been reviewed with Rulings, so that caution is warranted. However, based on prior rulings and the 2018 STEP Roundtable, the Directorate’s auditors would simply consider the income to be from property. There is nothing occurring other than passive income generation from the GIC.

Thus, here, the excluded share exemption would not be met, because there was no business. (It is also unlikely that an auditor would forward this matter to Headquarters to begin with.)

Scenario 2 - Corporate income derived from 3rd-party managed investments

A corporation that holds $5 million in portfolio investments is owned by 4 shareholders who are siblings. The shareholders range in age from 30 and 55. The portfolio is professionally managed by a third party investment manager and earns $500,000 of dividend income annually. The shareholders meet with the investment manager once a quarter to review the investment strategy and also meet once a year to decide on the quantum of dividends to be paid out in the fiscal year.

Are the activities of this corporation sufficient to constitute a business and if so, does the CRA consider this corporation to be earning business income for purposes of the TOSI rules?


This would depend on the facts. The interest would probably be income from property. As for the dividend income, it would be necessary to examine the level of trading activity in the financial instruments. Rulings and the courts have indicated a very low threshold for when a corporation has a business: there is almost a presumption. In this example, the auditor would be expected to take a closer look, and question the shareholders about the extent of their involvement with the portfolio activities.

The corporation likely has a business in this situation.

The distinction between what is and is not a business has not yet been raised in a TOSI context, but this distinction is not a new concept, and the auditors should have a good idea of the questions to ask and where to go for further information.

Scenario 3 - Car rental business

Company A is a car dealership. It owns its vehicles, and the majority of its revenue is from selling them. If Company B instead leases its vehicles, is it engaged in the provision of services?



However, the conclusion changes if Company B does not own its own vehicles, but is acting instead as a broker.

Scenario 4 - Insurance broker

An insurance brokerage sells insurance products on its website. Is it engaged in the provision of services?


It would be necessary for the auditor to first understands the legal relationship amongst the parties. However, note that Rulings at the 2018 CALU Roundtable indicated that insurance in general is a service.

Scenario 5 - Hotel with no guest services

A corporation operates a hotel. It was started by two spouses who each own 50% of the voting shares of the corporation. There are no restaurant operations in the business and the only income is from the hotel-related room revenue.


This question prompted considerable discussion in the Directorate.

In general, we think common sense dictates that hotels provide a service. However, in this example, the hotel is only engaged in renting rooms.

Rulings needs to be consulted on this because of inter alia the interplay with the specified investment business provisions and the small business deduction. The Directorate wishes to be consistent in saying what is a service for TOSI vs. how that might impact the small business deduction.

We hope to get that posted soon.

Scenario 6 - Landscaping business sells sod

Example 4 on CRA’s webpage entitled “Tax on split income – Excluded shares” holds that a cleaning business that spends 15% of its revenue on cleaning products is nevertheless engaged only in cleaning services, because the supply of cleaning products is incidental to the services.

Example 6, however, found that construction materials qualified as a non-service component of a construction business.

Consider a landscaping business, which generates income from cutting grass, fertilizing, and sodding – which entails buying grass. In CRA’s view, does this situation fall under Example 4 or 6?


This also provoked discussion. We want this “provision of service income” element to be largely mechanical for our auditors – in most cases the distinction between service and non-service should be fairly clear, so we do not want them spending much time on it.

In the example on the website, regarding the deck, what was highlighted was that the deck was a good that was sold - but it was necessary to divide it into parts and labour, where the labour is analogous to service income.

Applying that logic to the landscaping business, it probably would be concluded that it was for the provision of a service.

Tracing and Streaming


What will the audit position be for tracing and streaming in TOSI?


There are not any particular points right now about tracing that present a challenge for CRA. That does not mean that a tricky fact pattern does not exist somewhere, but our auditors are accustomed to tracing when checking on s. 20(1)(c) interest deductibility.

Our guidance for tracing in a TOSI context will rely on the same approach. Again, we want to make the instructions mechanical where possible.

"Reasonable Return"

Q.1 - Evaluation in the field

How will “reasonable return” be evaluated in the field?


In general the Directorate does not anticipate this being a difficult area as long as it is properly framed and that the auditors are provided with proper education. The Directorate has not yet received a referral on this issue but that could also be because it is still early. We would like to minimize subjectivity as much as possible.

On CRA’s webpage “Guidance on the application of split income rules for adults,” we state:

“In determining whether the payment is a Reasonable Return, the Agency does not intend to generally substitute its judgment of what would be considered a reasonable amount unless there has not been a good faith attempt to determine a reasonable amount based on the Reasonableness Criteria.”

Thus, the instructions to the auditors are to, first, question the taxpayers to determine what steps they took to verify that there was or was not split income. If there is a good faith attempt, then the auditors really do not have any need to question further.

If it appears there was not a good faith attempt then, as the website indicated, a variety of factors should be looked at. That includes the property contribution, the labour contribution, risk incurred or any other relevant factors. Our instructions for auditors will then be that they must verify that none of those factors apply before the amount can be considered as subject to TOSI.

The Directorate does not wish to spend too much time on what is or is not a reasonable return. Again, it would like to make the process mechanical where possible.

Q.2 - Instructions to auditors

2018-0771851E5 states that “CRA 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... .” Will that be reflected in an instruction to the field?


Assuming there are no other issues raised by the facts, then yes, the Directorate would accept a taxpayer’s good faith attempt. If there is a grey area, we might prefer to educate the taxpayer rather than assess.