CRA notes that unreasonable returns are bifurcated for TOSI purposes, and that loans to individuals do not generate split income

In an APFF question, CRA addressed the application of the tax on split income rules (TOSI) on strategies described to it as being intended to recover alternative minimum tax (planning which CRA addressed more directly in a subsequent question).

In the first scenario, Mr. X lent $100,000 to his spouse, Ms. X (also aged 30), at the 1% prescribed rate of interest. She then lent that amount as an unsecured loan to his wholly-owned personal holding company at a 5% rate of interest.

CRA noted that in these circumstances (e.g., she was essentially lending back to his company money that she got from him), it was “difficult to see how the factors enumerated in the definition of ‘reasonable return’ in subsection 120.4(1) could be satisfied.” Regarding what would be the impact if the holding company instead was equally owned by them, CRA stated that “the dividends received by Mr. X and Ms. X should also be considered in relation to Mr. X's and Ms. X's contributions to the related business, in order to determine whether the amount of interest income is otherwise a reasonable amount to Ms. X.”

However, if the interest at 5% was not a “reasonable return,” the split income amount of Ms. X would not be the total interest amount but, rather, only the excess over the reasonable return – so that, for example, if the reasonable return was 3%, her split income inclusion would be interest of 2%. (The statutory authority for this position appears to be the “to the extent of” language in the preamble of the excluded amount definition, so that this same approach could apply to other branches of the definition.)

In response to two other scenarios, CRA noted that, at least as a technical matter, the TOSI rules did not apply to loans by a specified individual at an unreasonably high rate of interest (including of funds derived from a related business) to a related individual (para. (d) of the split income definition only refers to loans to specified types of corporations, trusts and partnerships) or the payment of excessive salary by one spouse’s company to the other spouse (the specified individual) although, depending on the circumstances, it might review a GAAR application or (in the case of excessive salary) apply s. 67 or the benefit-conferral provisions.

Neal Armstrong. Summaries of 8 October 2021 APFF Roundtable, Q.2 under s. 120.4(1) – excluded amount – (g)(ii), split income – (d).