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: Is TOSI applicable on dividends derived solely from rental income
Position: Question of Fact
Reasons: If the activity of the corporation constitutes a "business", excluded share exception applies. If not, there may not be a "related business"
2021 STEP CRA Roundtable – June 15, 2021
QUESTION 4. TOSI on Dividends
Tom, Dick and Harry are brothers and Canadian residents. Many years ago they pooled their savings and incorporated TDH Co, a Canadian private corporation. Each owns 1/3 of the issued shares of the corporation. TDH Co owns three rental properties known as T, D and H. Each have equal value. The brothers live primarily on the dividend income of TDH Co and receive around $100,000 per year each. The brothers have never been active in managing TDH Co, which engages an outside arm’s length property management company to manage the properties. The initial capital was repaid many years ago.
a) Does the CRA agree that dividends received by Tom, Dick and Harry are subject to TOSI?
b) If a butterfly reorganization was done to split the corporation into 3 equal parts where Tom, via a corporation owned T, Dick via a corporation owned D, and Harry via a corporation owned H, would dividends received by Tom, Dick and Harry, as the case may be, thereafter be subject to TOSI?
CRA Response
a) In order to properly respond to this question, we have made the assumption that each of Tom, Dick and Harry (“Siblings”) are at least 25 years of age and own shares of TDH Co giving each such holder 10% or more of the votes and fair market value (“FMV”) of all the issued and outstanding shares of the corporation.
We have previously discussed whether shares of a corporation which derives its income from the rental of real property, inter alia, would constitute “excluded shares”, as that term is defined in subsection 120.4(1) of the Act, if the rental operations do not constitute a business.
For instance, in our response to Question 10 of the 2018 CTF Conference, which also referred to our response to Question 7 of the 2018 STEP conference, we indicated that where the level of activity in a corporation was enough to constitute a business, and the other conditions in the “excluded share” definition were met, such shares would be excluded shares. However, if there was not a sufficient level of activity to constitute a business, the shares of the corporation would not be excluded shares for the purposes of determining whether tax is payable on such dividends as split income under 120.4(2) of the Act (“TOSI”).
In this scenario, assuming the level of activity in TDH Co is sufficient to constitute a business that is carried on by TDH Co, which is a question of fact, the shares of TDH Co would appear to qualify as excluded shares. However, if it is determined that TDH Co does not carry on a business the excluded share exception would not apply and any taxable dividends received from TDH Co by the Siblings (each being a “specified individual”) would be subject to TOSI unless another exception applies. In this case, subparagraph (e)(i) of the definition “excluded amount” (applicable to individuals who have attained the age of 17 years before the year) would apply to prevent such taxable dividends from being subject to TOSI provided that such dividends are not derived directly or indirectly from a related business in respect of the individual for the year.
The expression “related business” in respect of a specified individual for a taxation year is also defined in subsection 120.4(1) and means, in the case of a corporation either: 1) a business carried on by the corporation if a source individual in respect of the specified individual at any time in the year is actively engaged on a regular basis in the activities of the corporation related to earning income from the business; or 2) a business of a corporation if a source individual in respect of the specified individual owns shares of the capital stock of the corporation or property that derives, directly or indirectly, all or part of its FMV from shares of the capital stock of the corporation and the total FMV of the shares and property equals at least 10% or more of the total FMV of all of the issued and outstanding shares of the capital stock of the corporation.
b) In this scenario, each of Tom, Dick and Harry, will undertake a “split-up” butterfly reorganization under paragraph 55(3)(b) of the Act such that each of the Siblings will ultimately indirectly own, through a holding corporation, a particular rental property formerly owned by TDH Co. In this scenario, although the ownership structure has changed, and the tax consequences of a butterfly transaction are beyond the scope of this response, the analysis with respect to the application of the TOSI rules in this scenario essentially remains the same as discussed in our response in part (a).
Ryan McPherson
June 15, 2021
2021-088314
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