You may have a TOSI issue if your investment company receives interest from a company for which your brother is an active employee

Each of three resident siblings were the respective beneficiaries, along with their spouses and children, of three trusts each holding an equal number of voting common shares of Investco with FMVs equaling at least 10% of that of the Investco common shares. (The siblings also held preferred shares of Investco directly.) Only one of the siblings was actively involved in the Opco business (as its full-time manager).

In 2019, Opco (which did not carry on a services business) redeemed its shares held by Investco in consideration for an interest-bearing term note. In 2019 and 2020, the bulk of Investco's revenues were Note interest, and the balance was investment income from a portfolio acquired out of dividends that had been received over the years from Opco. The dividends received in 2020 and 2021 by the three trusts on their Investco common shares were distributed and designated to the respective siblings under s. 104(19).

Regarding the application of the tax on split income (TOSI) rules on the assumption that Investco was carrying on an investment business, and focusing on the common share dividends that were funded with the note interest, CRA indicated that the Opco business in the 2019 to 2021 years was a related business in respect of the inactive siblings based on the active involvement in that business of their sibling and that the s. 104(19) dividend amounts allocated to the inactive siblings (which, by assumption, were derived from the note interest) thus were derived indirectly from a related business. (Such dividend income would be from an excluded business in the case of the actively-involved sibling.)

The essential problem for the two inactive siblings might seem to be that the Investco common shares held by them “through” their family trusts did not qualify as excluded shares because they did not “own” those shares, as required by the excluded share definition. Could they solve their TOSI issue if such common shares instead were distributed to them by their respective family trusts before the dividends were declared?

CRA answered, “no.” Para. (c) of the “excluded share” definition was not satisfied given that: for the 2020 year, substantially all of Investco's income for the preceding year (2019) was derived, directly or indirectly, from Opco's business, a related business in respect of those two siblings (given their sibling’s involvement therein); and for the 2021 year, most of Investco's income for the preceding year (2020) was derived (in the form of the note interest), directly or indirectly from such business.

CRA closed by noting that the siblings could “depending on the circumstances, benefit from the general reasonable return exclusion” in s. g(ii) of "excluded amount."

Neal Armstrong. Summary of 5 August 2022 External T.I. 2021-0877051E5 F under s. 120.4(1) – related business.