Section 120.4

Table of Contents

Subsection 120.4(1) - Definitions

Arm's Length Capital

Administrative Policy

5 October 2018 APFF Roundtable Q. 13, 2018-0778661C6 F - Tax on Split Income

no exclusion for arm’s length capital contribution where contribution derived from capital gain from related business

A family trust (“Trust”) distributed the taxable portion of its gain on the sale of qualified small business corporation shares (of Opco) to its beneficiaries (Mr. and Mrs. X, and their children, Child X and Y, aged 15 and 22) who claimed the s. 110.6 deduction. The Trust and its beneficiaries then used their sales proceeds to subscribe for the shares of a newly-incorporated holding company (Holdco): Trust – 50% of the Holdco shares; Mr. and Mrs. X – 20% each; and Child X and Y – 5% each). Holdco generated $150,000 from investing these funds in the stock market and paid a $100,000 dividend pro rata to its shareholders, so that Child Y received a $5,000 dividend.

CRA indicated that if Holdco instead was carrying on a business and, thus, a related business respecting Child Y, Child Y would not hold excluded shares given a shareholding of only 5%.

Child Y could not benefit from the exclusion for arm’s length capital contributions provided in s. (f)(ii) of the "excluded amount" definition given that the capital subscribed for Holdco shares came from a taxable capital gain from the disposition of property which directly or indirectly came from a related business (i.e., the shares of Opco).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares returns to a spouse and older children from a Holdco in which they reinvested their Opco capital gains exemption could qualify as excluded amounts 303
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(i) amounts not derived from a business were excluded amounts 149

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Exclusion for arm’s length borrowing even where no source-individual guarantee (p. 11)

The definition of “arm’s length capital” for adults who have not attained the age of 24 before the year excludes any borrowing by the specified individual under a loan or other indebtedness including from arm’s length sources. … If an individual borrows from an arm’s length party (e.g. a financial institution) without any security or guarantee provided by a source individual, that borrowing should conceptually be arm’s length. Finance should consider limiting paragraph (b) of the definition so that it carves out only those borrowings in connection with which financial assistance is provided by any source individuals who have attained the age of 24 before the year.

Excluded Amount

Administrative Policy

26 March 2013 External T.I. 2012-0465001E5 - kiddie tax

child care benefit

The minor child of the owner of a Canadian-controlled private corporation purchased the shares of the CCPC with money received in universal child care benefit and Canadian child tax benefit payments. In response to an inquiry respecting the application of s. 120.4 on the payment of dividends by the CCPC to the child, CRA stated:

An excluded amount does not include taxable dividends received by a specified individual in respect of shares in a CCPC that were purchased with money received from the UCCB even if the UCCB has been designated to that child under subsection 56(6.1) and is therefore included in the child's income, or the CCTB. These taxable dividends would therefore be included as split income for the specified individual and taxed at a rate of 29%.

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Failure of attribution rules to dovetail with excluded amount definition (p. 15)

  • Where s. 75(2) or 56(4.1) deems an amount of taxable capital gain to be “of the person”, it does not deem the person to have disposed of property, so that the attributed taxable capital gain cannot be an “excluded amount” (because the preamble requires a disposition of a property).
  • The deemed interest income inclusion under the subsection 74.4(2) corporate attribution rule is not deemed to be an income from property or from a specific debt obligation. It is unclear whether such deemed interest income could be caught under paragraph of the “split income” definition and if so, whether it can access the “excluded amount” provision.

Paragraph (a)

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

No exclusion for transfers from grandparents or perhaps adoptive parents (p. 11)

  • S. (a)(i) of “excluded amount” does not include transfers of property directly from grandparent to child.
  • It is unclear whether it extends to a child inheriting property from an adoptive parent (either legally or in fact).

Paragraph (b)

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

No exclusions for indirect s. 55(3)(a) transfers or extraordinary discretionary dividends on existing shares ((p. 10)

  • Where, following a separation, a holding company for one of the spouses receive assets through a s. 55(3)(a) spin-off transaction, the failure to receive property personally as described in s. 160(4) results in failure to access para. (b) of the “excluded amount” definition.
  • A significant dividend received, as part of an equalization arrangement. on a share already owned by the spouse also would not be protected by para. (b).

Paragraph (d)

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Insufficient flow through of attributes under QSBC provisions to beneficiary of trust (p. 16)

  • As the qualified small business corporation (“QSBC”) and qualified farm or fishing property (“QFP”) provisions do not deem the QFP or QSBC share to be owned by the beneficiary of a trust, a specified individual allocated such taxable capital gain cannot assess the exclusion in (d) of “excluded amount”, because the QFP or QSBC share is not “of the individual”.

Paragraph (e)

Subparagraph (e)(i)

Administrative Policy

3 December 2019 CTF Roundtable, Q.9

a transitional services agreement with an arm’s length purchaser can engage the TOSI rules

The (e)(i) exclusion applied where the corporation in question (which presumably is paying dividends to a specified individual who was never relevantly engaged in its business) has in a previous year sold its business to an arm’s length corporation which continues to actively carry on that business – unless the source individual in question continues an active involvement in that business, for example, under a transitional services business, in which case the related business exception would not be available to the specified individual.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Related Business - Paragraph (a) - Subparagraph (a)(ii) source individual status retained after arm's length sale if continued active involvement in business 414

11 June 2019 External T.I. 2019-0795291E5 F - Tax on Split Income - 120.4(1) excluded amount

dividend received from widowed step-mother's company was not re a related business

Mr. A bequeathed all the common shares of Opco to his surviving spouse, Ms. B, who was actively engaged on a regular, continuous and substantial basis in its business. Opco paid a dividend on the discretionary dividend shares held by Son A, who was the son of Mr. A, but not of Ms. B.

CRA noted that following the death of Mr. A, Son A no longer qualified as Ms. B's child under s. 252(1)(c) . Since she was now unrelated, Ms. B was not a "source individual" in respect of the specified individual (Son A). This, in turn, meant that Opco's business did not constitute a "related business" in respect of Son A, so that Son A could benefit from the "excluded amount" exclusion in s. 120.4(1)(e)(i): no TOSI.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Related Business no TOSI tax applied to a dividend received from the surviving step-mother’s company 213

27 November 2018 CTF Roundtable Q. 9, 2018-0779981C6 - TOSI–Excluded Amount - Non-Related Bus. Exception

“derivation” for TOSI purposes of dividends from previously earned income from a related business

Mr. and Mrs. A (both over 25) are equal shareholders of ACo, which two years previously sold the Old Business in which Mrs. A had been actively engaged on a regular, continuous and substantial basis for many years – but Mr. A, not at all. Since then, ACo’s sole activity has been the investing of the proceeds.

Where ACo’s investment activities did not constitute a business, will a dividend declared in the current year to Mr. and Mrs. A be considered to be an excluded amount?

CRA indicated that, as the Old Business had been wound up in a previous taxation year and ACo had no other related business, the dividends received were “excluded amounts” under (e)(i).

In another scenario, Mrs. and Mr. A (both over 25) are the respective sole shareholders of Opco (carrying on a non-services operating business) and Serviceco (earning income in Year 1 from Opco, but without Mr. A being actively involved in its business). In Year 2, Serviceco does not render any services and its activities are insufficient to constitute a business.

Where Serviceco’s Year 1 after-tax income is paid as a dividend to Mr. A in Year 2, would it be an “excluded amount” per (e)(i)?

CRA indicated that, as Serviceco earned its Year 1 income from the provision of services to Opco (i.e., derived amounts from Opco’s business) and the dividend paid in Year 2 can also be said to have derived directly or indirectly from the provision of services to Opco in Year 1 (and thus to be derived directly or indirectly from Opco’s business, being a related business), the Year 2 dividends would not be excluded amounts.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares investment business a business for excluded share purposes 159

2 November 2018 External T.I. 2018-0771861E5 - TOSI: Second generation income

dividends generated from the investment of dividends received from a related business (or gains from such investments) are not themselves derived from that business

Mr. and Mrs. A (both over 30) respectively own 100 voting and 100 non-voting common shares of Investco which wholly-owns Opco (with a non-services business). Only Mr. A is actively engaged in Opco’s business on a regular, substantial and continuous basis. Historically, Opco has dividended its earnings to Investco, with Investco then investing in dividend-bearing shares of publicly-traded corporations (the “portfolio”).

If Investco pays all of its portfolio dividend income to Mrs. A, would the dividend income received by Mrs. A be considered income that is derived directly or indirectly from a related business for s. 120.4 purposes? CRA stated:

Dividends paid by Investco out of its after-tax income from its investments in publicly-traded corporations would not be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A. Therefore, if Investco does not have a related business in respect of Mrs. A, the dividends it pays to Mrs. A that are derived from income and gains earned from its investments in publicly-traded corporations would be an “excluded amount” in respect of Mrs. A under subparagraph (e)(i) of … “excluded amount” … .

CRA then addressed an example where, in Year 1, Opco pays a $1M dividend to Investco and Investco then invests that dividend in shares of publicly-traded corporations. In Year 2, Investco pays a dividend-in-kind to Mrs. A of its entire stock portfolio which, at that time, has an aggregate FMV of $1.1M (for an accrued gain of $0.1M).

Before concluding that only $1.0M of the $1.1M dividend-in-kind received by Mrs. A would be derived from the related business of Opco in respect of Mrs. A (so that if Investco did not have a related business in respect of Mrs. A, $0.1M of the amount would not be derived from such a business), CRA stated:

The portion of the FMV of the distributed stock portfolio that represents the initial investment of the dividends paid by Opco to Investco would be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A. However, gains earned by Investco as a result of the investment of those dividends would not be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(d) amounts derived from a related business do not include capital gains from the passive investment of the dividends therefrom 255

5 October 2018 APFF Roundtable Q. 13, 2018-0778661C6 F - Tax on Split Income

amounts not derived from a business were excluded amounts

A family trust (“Trust”) distributed the taxable portion of its gain on the sale of qualified small business corporation shares (of Opco) to its beneficiaries (Mr. and Mrs. X, and their children, Child X and Y, aged 15 and 22) who claimed the s. 110.6 deduction. The beneficiaries then used their sales proceeds to subscribe for the shares of a newly-incorporated holding company (Holdco): Trust – 50% of the Holdco shares; Mr. and Mrs. X – 20% each; and Child X and Y – 5% each). Holdco generated $150,000 from investing these funds in the stock market and paid a $100,000 dividend pro rata to its shareholders.

CRA indicated that if it were determined that Holdco did not carry on a business, then the dividends received from Holdco would be “excluded amounts” for Mr. X, Mrs. X and Child Y under s. (e)(i) thereof because they were not derived from a business and, thus, not from a related business.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares returns to a spouse and older children from a Holdco in which they reinvested their Opco capital gains exemption could qualify as excluded amounts 303
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Arm's Length Capital no exclusion for arm’s length capital contribution where contribution derived from capital gain from related business 195

5 October 2018 APFF Roundtable Q. 11, 2018-0768821C6 F - Tax on Split Income

dividends derived from stock portfolio of Holdco excluded because stock portfolio not a related business or not a business

Mr. X holds all the voting shares of Opco, a family trust (“Trust”) holds all the participating shares of Opco, and Child X (age 30 and not involved in the Opco business) holds all the voting participating shares of Holdco, which generated $150,000 of passive income in the prior year from stock market investments. Holdco (which along with Mr. and Mrs. X, and Child X, is a Trust beneficiary) also received in the prior year a $100,000 distribution of a dividend that Trust had received from Opco, and now wishes to pay a $75,000 dividend to Child X (the “Dividend”). Would it be possible for Holdco to pay the Dividend on the basis that it was derived from income on the stock market investments rather than from Opco, so as to avoid the split income tax?

After noting that Mr. X was a source individual respecting Child X, assuming that Mr. X satisfied the active engagement condition with respect to Opco’s business, and further finding that if “Holdco will pay the Dividend to Child X out of the funds from the $100,000 dividend received from Opco or from any dividends previously received from Opco, then … the Dividend would thus have come, directly or indirectly, from a related business - that of Opco - in respect of Child X.” so that the Dividend would be added to the split income of Child X, unless it constituted an excluded amount by virtue of another exclusion, CRA then stated:

[I]f it can be determined that Holdco will pay the Dividend to Child X out of its after-tax income from its stock market investments, then that dividend would be an excluded amount for Child X and would not be included in calculating the child’s split income.

…[I]f it were determined that Holdco carries on a business whose primary purpose is to earn income from its stock market investments, that business would not qualify as a "related business" …[as] no source individual in respect of Child X satisfies the active engagement condition or the ownership condition with respect to Holdco. Consequently, the Dividend would be an "excluded amount" in respect of Child X… .

On the other hand, if it were determined that Holdco does not carry on a business, then the Dividend would also be an "excluded amount" in respect of Child X by virtue of subparagraph (e)(i) of the definition … [since] there must be … a business carried on by an entity. …

Based on the foregoing, Holdco must adequately monitor its funds derived from stock market investments in order to determine whether those funds were used to pay the Dividend.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Related Business - Paragraph (a) - Subparagraph (a)(i) stock market investing business of child's holdco not a related business as father not involved 284

Subparagraph (e)(ii)

Administrative Policy

3 December 2019 CTF Roundtable, Q.8

income derived from a prior year’s sale of an excluded business is not excluded

ABC Co., which was wholly-owned by a family trust, of which Mr. and Mrs. A (both over 24) are beneficiaries, carried on a trucking business in which both were actively engaged on a regular, continuous and substantial basis throughout the many years of operation. The proceeds of the sale of this business in 2018 were used to establish an investment business in which only Mrs. A is active. Will the excluded business exception apply to Mr. A, notwithstanding that the trucking business has ceased?

CRA noted that the investment business is a related business in respect of Mr. A, a specified individual, since Mrs. A, a source individual, is actively engaged in the activities of ABC Co.

The investment business directly carried out by ABC Co. is clearly not the same business as the former trucking business. Any taxable dividends that Mr. A receives are considered to be derived directly or indirectly from such investment business. As he is not actively engaged in that business, the amount will not be an “excluded amount” under (b)(ii) of that definition, because such amount will not be “derived directly or indirectly from an excluded business” of Mr. A “for the year.” Those are the key words.

Consequently, the taxable dividend received by Mr. A, will be subject to TOSI (unless another excluded amount exception applies).

6 August 2019 External T.I. 2019-0792001E5 F - Tax on split income and excluded business

no excluded amount where excluded business had ceased in prior year

Mr. X had for more than five years been actively engaged on a regular, continuous and substantial basis in the construction business of a wholly-owned corporation (ABC Inc.) However, ABC Inc. sold all its assets in 2015, and thereafter carried on a business of deriving revenues from an investments portfolio. Mr. X had no involvement in this business. Would a dividend received by him in 2019 be an excluded amount?

CRA indicated that the expression “derived directly or indirectly” in the “excluded business” definition had an expansive meaning – and also referred to the expansion of this expression in s. 120.4(1.1)(d). After referring to s. 120.4(1.1)(d)(ii), it added:

[T]o the extent that it could be determined that the amount in question was derived from the investment business carried on by ABC Inc., that amount could not constitute an "excluded amount" by virtue of subparagraph (e)(ii) of the definition … .

Turning to the “for the year” branch of (e)(ii) of the “excluded amount” definition, it stated:

[I]t would not be possible to consider that an amount distributed by a corporation in a year subsequent to the disposal of the activities of the business is derived from that business for the year. … [S]ince the construction business was not carried on in the year in which the dividend was received by Mr. X, it could not qualify as an excluded business of Mr. X for the year.

Essentially the same analysis and result obtained if a wholly-owned portfolio company of Mr. X (“Portfolico”) had held ABC Inc. before its sale in 2015, and used the proceeds in its portfolio business.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) paid but non-worked days do not count 176
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(d) - Subparagraph 120.4(1.1)(d)(ii) same-year limitation of the exclusion for income derived from the proceeds of an excluded business 222

19 August 2019 External T.I. 2019-0814181E5 - TOSI - interpretation of "excluded business"

5-year excluded business exception can take into account involvement while business held by predecessor

Para. (b) of the “excluded business” definition of the tax on split income (TOSI) rules includes in an excluded business of a specified individual for a taxation year a business in which she was “actively engaged on a regular, continuous and substantial basis” (“Involved”) in “any five prior taxation years.” CRA followed the guidance in Finance’s Explanatory Notes and found that the five year test could be satisfied where the specified individual was Involved in the business for, say, three years while it was conducted by her spouse as a sole proprietorship, and for a further three years after it was rolled by him into a newly-incorporated Opco. In other words, it was the same business for TOSI purposes throughout the six years.

Accordingly, after she retired, she could receive a s. 104(19)-designated Opco dividend qua beneficiary of a family trust without being subject to the TOSI.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Business - Paragraph (b) drop-down of business does not restart the 5-year count 252

25 May 2018 External T.I. 2018-0761601E5 - Correspondence with XXXXXXXXXX re Tax on Split Income

where spouse works in only one of two businesses, excluded amount determination requires “separate accounting for each business and a tracing of funds”

The spouse (Spouse B) of the shareholder of a corporation with a construction and property management business works 25 hours in the property management business, but not in the construction business. Must the flow of funds be traced from the property management business to Spouse B to ensure they are “excluded amounts”? After noting that the property management, but not the construction, business thus would be an excluded business of Spouse B,

[A]ny income of Spouse B that is derived directly or indirectly from the property management business will be income from an excluded business of the spouse and will not be split income subject to TOSI. Any income of the spouse that is derived directly or indirectly from the construction business will not be income from an excluded business of the spouse and will be split income subject to TOSI unless another exclusion applies. This will require separate accounting for each business and a tracing of funds.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (b) no excluded share exception where interposition of family trust or holdco 121
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) keeping time logs will “ensure that businesses are able to comply with the new rules” 173
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (a) - Subparagraph (a)(i) shares of pizzeria but not hair salon were excluded 232

Paragraph (g)

Articles

Govindadeva Bernier, Tim Scholz, "Income Sprinkling Using Private Corporations", Office of the Parliamentary Budget Officer (with thanks to “Finance Canada officials for their helpful technical discussions”), 8 March 2018

Overview of 13 December 2017 changes (pp. 6-7)

Specified individuals aged 18 to 24 would be required to provide a greater labour contribution, as they would have to be actively engaged on a regular, continuous and substantial basis in the activities of the business.

On the other hand, individuals aged 25 and over would only need to be involved in the activities of the business (that is, they contributed labour that could have otherwise been remunerated by way of salary or wages).

“Actively engaged in the activities of the business” is defined as working on average at least 20 hours per week during the part of the year in which the business is operational. This average of 20 hours per week must have taken place during the current year, or a combination of any five previous years.

If this criterion is met, any dividend received from the family business in which the individual was actively engaged is excluded from the new TOSI rules. This would apply only in the year in which the individual was actively engaged if he or she has not yet reached five years of active engagement.

For children aged 18 to 24, the active labour contribution is the only way to completely exclude all the dividends received from the new TOSI rules. For any family member aged 25 and over, the same exclusion will prevail if they work at least 20 hours per week on average in the current year or any five previous years.

However, even if they don’t reach the 20-hour threshold, they can still receive a reasonable amount of dividend based on the labour contribution they will have provided and the TOSI will apply only on the unreasonable excess.

The same applies for capital contributions, as a legislatively- prescribed maximum return on the assets contributed by the individual would be imposed for those aged 18 to 24. On the other hand, individuals aged 25 and over would only be required to have contributed assets or assumed risk in support of the business.

The December announcement provided a further way of excluding dividends from the extended TOSI rules. Indeed, if a family member aged 25 and over owns at least 10 per cent of the shares of the family CCPC (in terms of votes and value), and if that corporation earns less than 90 per cent of its income from the service sector and is not a professional corporation, then all dividends received are excluded from the new rules.

Furthermore, for family members aged 25 and over, TOSI will apply only in cases where it is evident that an amount received is disproportionate relative to the contributions. The new rules will also not apply to the spouse of a CCPC owner aged 65 and over, to align with existing tax law which allows pension income splitting for seniors.

Finally, the December announcement also made some additional changes to the initial proposal. Here are the most important with regards to our costing exercise:

  • The definition of “related individual” will not be extended to an aunt, uncle, nephew or niece unlike what was initially intended in July’s proposals.
  • The Government will not proceed with the proposed measures to apply the TOSI to compound income (that is, income earned from the investment of an initial amount of income that is subject to the TOSI or attribution rules).
  • A person inheriting property will generally not face a less favourable treatment than the deceased.

Subparagraph (g)(i)

Administrative Policy

5 October 2018 APFF Roundtable Q. 9, 2018-0768801C6 F - Tax on Split

inactive spouse could receive excluded amount dividends from Holdco if its income was from an active business of reinvesting Opco dividends

2018 STEP Roundtable Q.7 indicated that the shares of a holding company (or of a company generating no business income) cannot qualify as excluded shares for purposes of the split income rules. CRA noted that if the company instead has “a business whose principal purpose is to derive income from property, including interest, dividends, rents and royalties, such as investment management corporations” then “the condition in subparagraph (a)(i) of the definition of “excluded shares" in subsection 120.4(1) would be satisfied.”

For example:

  • Mr. and Mrs. X (both age 35) respectively hold 90% and 10% of the voting common shares of Holdco
  • Holdco holds all the shares of Opco in whose business Mrs. X has no involvement
  • Holdco in its preceding year did not receive any dividends from Opco and it holds passive investments (acquired some time ago out of dividends received from Opco) which, in the previous year, generated interest and dividends of $100,000,
  • Holdco now pays a dividend (representing much of the previously received income) pro rata to Mr. and Mrs. X.

CRA considered that Mrs. X's shares are “excluded shares” if such $100,000 of income was “derived from the carrying on of a business the purpose of which is to earn interest income and dividends … notwithstanding the fact that the capital used in the acquisition by Holdco of the property used in carrying on its business was derived from dividends received from Opco.” As the dividend received by her would constitute an "excluded amount" per s. (g)(i) of the definition thereof, she would not be subject to the split income tax thereon.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (a) - Subparagraph (a)(i) portfolio investment company might qualify as having a business 480

Subparagraph (g)(ii)

Administrative Policy

7 August 2019 External T.I. 2019-0814161E5 - Application of Reasonable Return - TOSI

broad construction of reasonable return exception would violate TOSI policy

An individual (Spouse B) who, quite unlike Spouse A, was not involved in the business of Opco, received distributions of s. 104(19) dividends from a discretionary family trust following their declaration and payment by Opco to Holdco, and by Holdco to that trust. These dividends could not qualify in Spouse B’s hands as being from excluded shares, and CRA also found that they could not qualify under the “reasonable return” exception in the “excluded amount” definition for exclusion from split income, notwithstanding that all the shares of Opco originally had been issued to Spouse A for cash subscription proceeds that came out of a joint bank account of Spouses A and B.

CRA stated:

[A]lthough the cash used to fund Spouse A’s initial share investment … was stated to be from cash that came from a joint account … the legal form of these transactions strongly suggests that Spouse B has not made any direct or indirect contribution of property to Opco. …

[T]aking an overly broad interpretation that a specified individual has made an indirect financial contribution to a business such that the reasonable return exception in subparagraph (g)(ii) of the definition of excluded amount would apply to prevent the amount from being split income would appear to frustrate the underlying tax policy of the TOSI rules.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Reasonable Return shares subscribed for out of a joint bank account should not be treated as having been funded by a passive spouse in applying the reasonable return TOSI exception 240

Excluded Business

Administrative Policy

7 June 2019 STEP Roundtable Q. 4, 2019-0799911C6 - TOSI & Meaning of Excluded Business

an excluded amount can exceed arm’s length remuneration for the services rendered

The spouse of a professional works over 20 hours per week as a part-time receptionist in the professional practice of his corporation (XCo). She does not receive a “market” salary for her services of $18,000, and instead receives an annual dividend of $150,000 on her non-voting preferred shares of XCo.

CRA indicated since she satisfies the 20 hours per week test in s. 120.4(1.1)(a), her dividend income would be an excluded amount because it is derived from an excluded business – so that it would not be subject to the tax on split income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) spouse on achieving 20-hour threshold could receive large dividends as excluded amounts 115

7 June 2019 STEP Roundtable Q. 3, 2019-0799901C6 - TOSI and Hours Worked

husband and wife each contributing 5 hours per week to business could have an excluded business

A business is carried on through a corporation owned by husband and wife, who each contribute 5 hours per week of time to the business. Is the business an excluded business?

CRA noted that whether an individual has been “actively engaged on a regular, continuous and substantial basis in the activities of the business” (“actively engaged”) will depend on the circumstances, including the nature of the individual’s involvement in the business, i.e., the work and energy that the individual devotes to the business and the nature of the business itself – so that, the more an individual is involved in the management and/or current activities of the business, the more likely it is that the individual will be considered to be actively engaged.

After further noting that the facts here were similar to Example 9 of CRA’s split-income guidelines, CRA indicated that in the current scenario, both the husband and wife could be considered to be actively engaged in the business, even though neither of them reaches the 20-hour threshold in s. 120.4(1.1)(a).

It was a question of fact whether the husband and wife could be considered to satisfy the excluded business test for a particular year or continue to meet such test thereafter, as consideration must be given to the ongoing nature and labour requirements of the corporation’s business.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) falling below 20 hours not presumptive 74

3 December 2018 CPA Canada Roundtable, 2018-0773811C6 - Tax on Split Income (TOSI)

excluded based on prior 5 years

Example V: Excluded business based on prior 5 years (pp. 33-34)

Farmco’s shareholders are Father, Mother and a Family Trust for Child 1 and Child 2. For 6 of the last 7 years, Child 2 (aged over 18) has worked on average of more than 20 hours per week during the 40-week period of operation of the farming business of Farmco, but in the most recent year, Child 2 took the summer off and did not achieve the 20 hours average.

A dividend paid by Farmco to Family Trust and distributed by it to the children including Child 2 is an excluded amount derived directly or indirectly from an “excluded business” given that Child 2 (the specified individual) was actively engaged etc. in the related business for five prior taxation years.

26 September 2018 External T.I. 2018-0770911E5 - Revised income sprinkling rules

parental leave did not detract from satisfying activity level test

Regarding the 20-hour rule in s. 120.4(1.1)(a), the Explanatory Notes state:

An average work commitment of less than 20 hours per week could qualify as regular, continuous and substantial where, for example, an individual works 30 hours per week in a year-round business up to the start of July, after which they are unable to continue working throughout the remainder of the year (e.g., because of injury, illness or the birth or adoption of a child).

CRA essentially adopted this statement and stated:

[T]here are certain situations where the average work commitment could be considered as being “regular, continuous and substantial” even if the bright-line deeming rule is not met. Accordingly, the fact that an individual was unable to work for a portion of a year in which the business operated due solely to the adoption or birth of a child would not, in and by itself, mean that the individual was not otherwise considered to meet the regular, continuous and substantial requirement for that year.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) parental leave need not detract from satisfying the regular, “continuous” and substantial TOSI test 227

Guidance on the application of the split income rules for adults 15 December 2017 CRA Webpage

Example 4 (under 25 and over 20 hours)

Dividends from Farmco paid to a children’s trust and distributed to an age-20 child who works 20 hours per week in the business are excluded amounts.

Example 5 (under 25 and under 20 hours)

An Opco dividend distributed by family trust to grandchild (age 19) working one day per week in Opco business is not from an excluded business.

Example 5A (reasonable-return dividend not excluded if under 25)

An Opco dividend distributed by family trust to a child (age 20) working 600 hours each summer in Opco business is not from an excluded business.

Example 7 (child acquiring Opco receives large dividend before exceeding hours test)

Parent who worked full-time in the business of Opco, which is a small business corporation, retires and sells all the shares of Opco to Child, who now manages the business, but does not meet the 20 hour average test because the sale occurred part way through the year. A large dividend paid to Child at year end is an excluded amount because Child is actively engaged in the business and because the dividend represents a reasonable return.

Example 9 (business requires less than 20 hrs/week)

Spouses A and B, each aged 23, equally own and founded a mobile-apps company, on which they work on evenings and weekends (less than 20-hours per week) as the only employees. Their dividends are from an excluded business.

Example 10 (dividend of over-25s on gain from jointly supervised real estate)

Siblings A, B and C founded Real Estateco with nominal capitalization and built it up through 3rd-party financing (using personal guarantees) and a 3rd-party manager. Dividends received by them (now, over 25) following a sale of one of Real Estateco’s rental properties at a gain is from excluded shares and also represents a reasonable return “having regard to the risks they assumed as directors of Real Estateco, their supervision of Third Party and their involvement in Real Estateco’s strategic decisions.”

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

5 taxation years of the specified individual may be what is referenced (p. 13)

  • It is unclear whether “any five prior taxation years” refers to taxation years of the individual or of the entity carrying on the business.
  • "Given that the definition of ‘excluded business’ (as well as the 20-hour deeming rule in paragraph 120.4(1.1)(a)) is relevant to a taxation year of the specified individual, it appears that [this phrase] refers to taxation years of the specified individual."

Paragraph (a)

Administrative Policy

11 October 2019 APFF Roundtable, Q.18

loss of excluded business exception when specified individual went on extended mat leave or disability

Individual B is a source individual in respect of Individual A. Individual A holds only 5% of the shares of Aco but is “actively engaged on a regular, continuous and substantial basis” (“Involved”) in the active business of Aco for 2017 through 2019, so that the dividends received by her on her shares of Aco are excluded amounts.

If Individual A were on maternity leave throughout 2020, or could not work during that period because of an accident, but thereafter returned to work on the same Involved basis as before, would she be considered to be Involved during 2020? What if the accident rendered her permanently disabled?

CRA responded:

The more an individual is involved in the management and/or day-to-day operations of the business, the more likely it is that the individual will be considered to be actively engaged in the business, on a regular, continuous and substantial basis. Similarly, the more an individual's involvement is integral to the success of the business, the more it would be considered important.

… Individual A will be absent for her entire 2020 taxation year … . As a result, Aco's business will not be an excluded business in respect of Individual A for her 2020 taxation year, as well as for subsequent taxation years in the permanent disability scenario.

That said, [where] the various exclusions, including those respecting an excluded business … do not apply in a particular situation, the underlying logic is that, in such circumstances, the most appropriate test, in determining whether the income from a related business respecting a specified individual should be excluded from the calculation of split income, should be based on the general test as to whether the amount constitutes a "reasonable return" based on the specific criteria applicable in the circumstances, including the work performed, the property contributed, the risks assumed, the total amounts paid or payable and such other factors as may be relevant.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Reasonable Return potential application of reasonable return exception where on mat leave or disability 201

Paragraph (b)

Administrative Policy

19 August 2019 External T.I. 2019-0814181E5 - TOSI - interpretation of "excluded business"

drop-down of business does not restart the 5-year count

A source individual (“Mr. A”) transferred his catering business to a newly incorporated corporation (“Opco”) in consideration for Opco preferred shares, with a family trust (“Trust”) subscribing for common shares. Mrs. A (one of the beneficiaries) had been actively engaged on a regular, continuous and substantial basis (“full-time”) as an employee of Mr. A’s catering business, but for less than 5 years and was so employed and engaged in the Opco business thereafter, also for less than 5 years. She then completely ceased working in Opco’s catering business, such that the combined period of her working full-time in the catering business both before and after the Opco incorporation exceeded 5 years.

Opco then pays a dividend to the Trust, which is then designated under s. 104(19) to be a taxable dividend received by Mrs. A. In finding that the excluded amount exception applied to this dividend, CRA stated:

[T]he reference to a “business” in the preamble of the excluded business definition should not, for the purposes of paragraph (b) of that definition, exclude taking into account taxation years where that business was carried on in another form. Our view is supported by the … Explanatory Notes … .

Therefore … since it has been assumed that Mrs. A has been actively engaged on a regular, continuous and substantial basis in the catering business, carried on first by Mr. A as a sole proprietor and subsequently by Opco, for at least five prior taxation years, the requirement in paragraph (b) of the excluded business definition would be met.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(ii) 5-year excluded business exception can take into account involvement while business held by predecessor 148

27 February 2019 External T.I. 2018-0783741E5 - TOSI and the meaning of "Excluded Business"

the 5 year period can be many years before, discontinuous and while an unrelated individual

From 2001 to 2006 inclusive, Ms. B was employed 40 hours per week in the active business of Opco (wholly owned by Mr. A), then ceased working. In 2018, Mr. A and Ms. B (now both 35) married and Ms. B acquired non-voting shares of Opco (while continuing to do no work for it). Is her dividend income an “excluded amount” because “excluded business,” para. (b) exception based on her previous employment? CRA responded:

[T]here is no requirement that the prior taxation years where the specified individual is actively engaged on a regular, continuous and substantial basis must be consecutive, nor is there a requirement that the specified individual must be related to the particular source individual at the time such qualifying activities are performed. … [and] these years can be before the effective date of the amendments to section 120.4. …

[A]ssuming Ms. B has been actively engaged on a regular, continuous and substantial basis in the business activities of Opco for at least five years, the five-year test in paragraph (b) of the definition of “excluded business” would appear to be met.

Excluded Shares

Administrative Policy

7 November 2018 External T.I. 2018-0777361E5 - TOSI and dividend income, including from a trust

an estate is a blocker for accessing the TOSI excluded share exemption

In 2018, the estate of the Deceased (the “Estate”) acquired all the voting preferred shares of “Investco” (a taxable Canadian corporation which had been carrying on an investment business generating interest and dividends for several decades) for their FMV pursuant to s. 70(5). Such shares represented more than 10% of the voting rights and FMV of Investco.

The Deceased’s three children (all over 24 and Canadian residents) were the sole beneficiaries of the Estate. Each child’s common shares of Investco represent more than 10% of the voting rights and FMV of Investco.

All the shares of Investco are to be redeemed, resulting in deemed dividends which, in the case of the Estate, may be allocated to the children. Do the split income rules apply?

CRA noted:

  • the children (and the Deceased in 2018) were specified individuals and source individuals
  • “if the deemed dividend income on the preferred shares owned by the Estate is allocated to the children, such income will be split income unless it is an excluded amount”
  • “the business of Investco appears to be a related business in respect of the Deceased and the children,”
  • the “excluded amount” exclusion included “income received by a ‘specified individual,’ age 24 or over, from owning ‘excluded shares’ [emphasis added]
  • respecting the excluded share definition, the tests in paras. (a) and (c) were satisfied

CRA further stated:

[I]f immediately before the time the common shares of Investco are to be repurchased, the children each own more than 10% of the voting rights and value of Investco (“votes and value test”) represented by the common shares they own, the requirements set out in (b) above also would be met. However, with respect to the preferred shares of Investco owed by the Estate, while those shares also appear to satisfy the votes and value test, they do not satisfy the ownership requirement set out in (b) [of “excluded amount”] … .

…Accordingly, any deemed dividends arising on the redemption of the preferred shares, if allocated to the children by the Estate, would be subject to TOSI unless another exception applies.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(b) general discussion of s. 120.4(1.1)(b) 313

27 November 2018 CTF Roundtable Q. 10, 2018-0780081C6 - TOSI – Excluded Shares & Related Business

exclusion for investment business or passive amounts not derived from a related business

29 May 2018 STEP Roundtable Q.7, 2018-0744031C6 indicated that the shares of a corporation that did not generate business income (e.g., a corporation that generated rents that, given the level of activity, constituted income from property ) cannot qualify as excluded shares, whereas in Examples 8 and 12 of the Guidance on the Application of the Split Income Rules for Adults (December 13, 2017), shares of a corporation earning income from passive investment assets qualified as excluded shares. How should these positions be reconciled?

CRA noted that if in Q.7 of STEP 2018, if it instead were assumed that the corporation carried on a business, the corporation’s shares could qualify as excluded shares. On the other hand, even if it did not carry on a business, the amount received from the corporation by the specified individual would qualify as an excluded amount if it were not derived, directly or indirectly, from a related business in respect of the individual for the year.

This response is similar to 5 October 2018 APFF Financial Strategies and Instruments Roundtable, Q.2 and 5 October 2018 APFF Roundtable, Q.9(a).

27 November 2018 CTF Roundtable Q. 9, 2018-0779981C6 - TOSI–Excluded Amount - Non-Related Bus. Exception

investment business a business for excluded share purposes

Mr. and Mrs. A (both over 25) are equal shareholders of ACo, which two years previously sold the Old Business in which Mrs. A had been actively engaged on a regular, continuous and substantial basis for many years – but Mr. A, not at all. Since then, ACo’s sole activity has been the investing of the proceeds.

If ACo’s investment activities constituted a business during ACo’s last taxation year and generated positive gross revenue during that year, are Mr. A’s shares “excluded shares” in the current year?

In indicating that the excluded shares exception would be available, CRA noted that para. (a) would be satisfied because Aco carries on a business the income from which is derived from property, the share ownership tests in para. (b) are satisfied, and (respecting para. (c)) Aco’s income for the last taxation year would not have derived directly or indirectly from another related business other than the business of Aco.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(i) “derivation” for TOSI purposes of dividends from previously earned income from a related business 273

5 October 2018 APFF Roundtable Q. 13, 2018-0778661C6 F - Tax on Split Income

returns to a spouse and older children from a Holdco in which they reinvested their Opco capital gains exemption could qualify as excluded amounts

A family trust (“Trust”) distributed the taxable portion of its gain on the sale of qualified small business corporation shares (of Opco) to its beneficiaries (Mr. and Mrs. X, and their children, Child X and Y, aged 15 and 22) who claimed the s. 110.6 deduction. The Trust and its beneficiaries then used their sales proceeds to subscribe for the shares of a newly-incorporated holding company (Holdco): Trust – 50% of the Holdco shares; Mr. and Mrs. X – 20% each; and Child X and Y – 5% each). Holdco generated $150,000 from investing these funds in the stock market and paid a $100,000 dividend pro rata to its shareholders with Trust, in turn, distributing its $50,000 dividend to Mrs. X and Child X and Y.

Are the dividends paid by Holdco to Mr. and Mrs. X and Child X and Y, and distributed by Trust to the latter three subject to split income tax? CRA indicated:

  • The dividend paid by Holdco to Child X clearly would be added to the child’s split income given the age of under 17.
  • If it were determined that Holdco did not carry on a business, then the dividends received from Holdco would be “excluded amounts” for Mr. X, Mrs. X and Child Y under s. (e)(i) thereof.
  • If Holdco instead was carrying on a business and, thus, a related business respecting Mr. X, Mrs. X and Child Y, the shares of Mr. and Mrs. X would be excluded shares given that they had the greater than 10% shareholdings described in s. (b) of the excluded share definition, under s. (a) of that definition Holdco’s income was from property, and under s. (c), all or substantially all of Holdco’s income was from its own business. However, Child Y would not hold excluded shares given a shareholding of only 5%.
  • A similar analysis applied to the distribution by Trust.
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Arm's Length Capital no exclusion for arm’s length capital contribution where contribution derived from capital gain from related business 195
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(i) amounts not derived from a business were excluded amounts 149

29 May 2018 STEP Roundtable Q. 7, 2018-0744031C6 - Excluded Shares

a corporation with only property income does not accord excluded share status

Assume that a corporation has no business income because it derives income from property (possibly rental income from real property where the activities are not sufficient to constitute business income).

CRA indicated that as the corporation has no business income, its shares cannot qualify as excluded shares. Where both the business and service income are nil, that will not satisfy the 90% requirement, as 0 is being compared to 0.

29 May 2018 STEP Roundtable Q. 6, 2018-0743971C6 - Excluded Shares – Holding Company

holding company shares do not qualify as excluded shares

In general terms, is it possible for shares of a holding company to qualify as "excluded shares"?

CRA indicated that the definition of excluded shares should generally not include the shares of a Holdco, because all or substantially all of its income would be derived from a related business with respect to the individual. Any income or taxable capital gains from the dispositio­­n of such shares will not be an excluded amount and will be split income of the individual subject to TOSI unless another exclusion applies, for example, if the related business is itself an excluded business.

Where this or other safe harbours do not apply in a particular case, the determination of whether the income of a specified individual from a related business should be excluded from split income treatment generally should be based on a general test of whether the amount received is a reasonable return according to the specific factors applicable in the circumstances, which include the work performed, properly contributed in support of the business, the risks assumed by the specified individual or related individual, prior amounts received by or in respect of the business, and any other relevant factor.

29 May 2018 STEP Roundtable Q. 5, 2018-0743961C6 - Tax on Split Income

“income” means “revenue,” and incidental property revenue is assimilated to services revenue

In the definition of excluded shares, subpara. (a)(i) refers to 90% of the corporation’s "business income" whereas para. (c) uses "all or substantially all of the income". Does “income” refer to net income? If yes, does this require a segmented computation of business income as between income from services and from other sources?

CRA indicated that the references to “business income” and “income” in paras. (a) and (c) respectively both generally mean gross income. Thus, subpara. (a)(i) of that definition requires that less than 90% of business income of the corporation was from the provision of services.

Where the corporation has income from the provision of services and from income from non-services, the two should generally be computed separately, and the non-service income considered in determining if the requirement of the definition is met. However, where the non-service income was necessary for or incidental to the provision of the services themselves, all of the income would be considered to be services income.

Words and Phrases
income

Guidance on the application of the split income rules for adults 15 December 2017 CRA Webpage

Example 3B (inactive spouse holding excluded shares)

Dividend paid by Opco (a components business) only on the class of voting discretionary shares (50% of equity) held by over-25 inactive spouse is an excluded amount.

Example 8 (retired owner-managers holding excluded shares)

Dividends paid by Investco, which a number of years ago had ceased to carry on an active business managed by Siblings A and B, to its two equal shareholders (Sibling A, who is retired, and the widow of Sibling B) are from excluded shares.

Example 10 (dividend of over-25s on gain from jointly supervised real estate)

Siblings A, B and C founded Real Estateco with nominal capitalization and built it up through 3rd-party financing (using personal guarantees) and a 3rd-party manager. Dividends received by them (now, over 25) following a sale of one of Real Estateco’s rental properties at a gain is from excluded shares and also represents a reasonable return “having regard to the risks they assumed as directors of Real Estateco, their supervision of Third Party and their involvement in Real Estateco’s strategic decisions.”

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Para. (c) exclusion for income form a related business taints a holding company receiving dividends from a wholly-owned Opco with an active business (pp. 5-6)

  • Mr. A, Ms. B and their son, AB, are equal shareholders of AB Co which carries on an active business. AB (age 25) unlike his parents who are active participants, has never been active in the business. Shares of AB Co are likely “excluded shares,” so that AB may receive an unlimited dividends without TOSI applying.
  • Mr. E, Mrs. E and their son, EE, are equal shareholders of E Holdco, which holds 100% of E Opco that carries on an active business. E Opco distributed all its earnings to E Holdco as dividends. Mr. E and Mrs. E both actively engaged in the E Opco business, whereas EE (aged 25) and had never been active in the business. Shares of E Holdco cannot be “excluded shares” because all or substantially all of its income is derived, directly or indirectly, from a “related business,” i.e., its sole source of income was dividends received from E Opco, which paid the dividends out of a “related business”. Any dividend income or taxable capital gain earned by EE in the current year in respect of his E Holdco shares will be subject to TOSI.

Exclusion of shares held through trust (p. 13)

The preamble of the “excluded shares” definition requires that the shares be “owned by the specified individual”. Since subsection 104(2) deems a trust to be a separate individual in respect of trust property, a specified individual who is a beneficiary of a trust can never access the “excluded shares” exception with respect to shares held by the trust.

Failure of attribution rules to dovetail with excluded shares definition (p. 15)

Attributed dividend income can never qualify for the “excluded shares” exclusion because attribution does not deem the specific share from which the dividend arises to be owned by the individual to whom income or capital gain is attributed.

Definition does not extend to a partial under-10% bloc (p. 16)

  • The exclusions in s. (g)(i) of “excluded amount” apparently does not apply to a taxable capital gain arising where the specified individual undertakes a partial disposition such that the shares being disposed of are below the 10% votes and value threshold.
  • E.g., Mr. A, holding shares of Opco representing 20% of the votes and value, sells a bloc representing 5% of the votes and value.

Paragraph (a)

Subparagraph (a)(i)

Administrative Policy

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

quaere whether low-service hotel business is a services business

Paul Wilson (Director, Medium Business Audit Division, Small and Medium Enterprises Directorate) provided comments noted below on the following scenarios:

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?

Mr. Wilson indicated “no” – but noted that 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?

Mr. Wilson indicated that it would be necessary for the auditor to first understand the legal relationship amongst the parties, but noted that 8 May 2018 CALU Roundtable Q. 6, 2018-0745871C6 indicated that insurance generally 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.

Mr. Wilson indicated that although common sense dictates that hotels provide a service, here 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. Hopefully, an answer will be posted soon.

Scenario 6 - Landscaping business sells sod

Example 4 on CRA’s webpage entitled “Tax on split income – Excluded shares” indicated 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, whereas Example 6 found that construction materials qualified as a non-service component of a construction business.

How would a landscaping business, which generates income from cutting grass, fertilizing, and sodding – which entails buying sod – be treated?

Mr. Wilson indicated that in Example 6, what was highlighted was that there was the sale of a good (the deck) but that even within it, it was necessary to divide into parts and labour, where the labour is analogous to service income.

In the case of the landscaping business, the conclusion likely would be reached that the landscaping business was for the provision of a service.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Related Business low threshold for determining whether there is a business for TOSI purposes 303

Tax on split income – Excluded shares (CRA webpage) 10 July 2019

Example 3 (plumbing business with changing mix)

A corporation generates 95% and 5% of its revenues in 2017 from repair and maintenance services and sales of parts and fixtures, with these respective percentages being 75% and 25% in 2018. It will satisfy (a)(i) of the excluded share definition in 2019, but not 2018.

Example 4 (incidental goods used in cleaning services subsumed in services revenue)

A corporation that operates a cleaning business uses cleaning products in providing services to its customers and may list separately an amount on its invoices for such goods. CRA indicated:

[T]he cleaning products are incidental to the services, since they were used in providing the services [so that] the incidental goods amount … would not be subtracted from the service part of the gross business income

i.e., 100% of its revenue would be services revenue.

Example 5 (cleaning supplies sold to services customers not included in services revenue)

The cleaning business in Example 4 now also sells cleaning supplies and equipment separately, including to customers when they are buying cleaning services. CRA stated:

[T[he business had sales of cleaning supplies and equipment that were not incidental to the services, since they were either sold separately or, if sold with a cleaning service, were distinct and separate from the cleaning service. … [S]ales of the cleaning supplies and equipment would not be included in the service part of the gross business income.

Any incidental goods used or consumed in performing the cleaning services would not be subtracted from the service part of the gross business income.

Example 6 (separate charges of deck construction company for labour and materials are respected)

A corporation engaged in the design, construction and repair of decks supplies all materials and labour when constructing and repairing the decks – and for a fee, also designs decks and provides plans to customers who want to build the deck on their own.

Gross business income of the corporation (2017): $200,000 made up as follows:

  • Deck construction: $175,000:
    • Materials $90,000
    • Labour $85,000
  • Deck repairs: $20,000:
    • Materials $10,000
    • Labour $10,000
  • Deck design: $5,000
  • Gross business income for services: $100,000 ($200,000 − $90,000 − $10,000)
  • Gross business income test: $100,000 ∕ $200,000 = 50%

Since less than 90% of the business income from all activities of the corporation is for services, the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares is met. So the shares of the corporation would qualify as excluded shares in 2018.

3 December 2018 CPA Canada Roundtable, 2018-0773811C6 - Tax on Split Income (TOSI)

when property is ancillary

Gross income from services v. goods

Where goods are provided in combination with a service and the goods are not incidental (e.g., auto repairs and home renovations) the revenue from the goods will be considered. Conversely, services can be incidental to the sale of goods, e.g., the delivery and installation of goods sold. CRA recognizes that billing practices and accounting systems may not specifically identify revenue from non-services, so that there is flexibility when reviewing such situations.

5 October 2018 APFF Financial Strategies and Instruments Roundtable Q. 2, 2018-0765791C6 F - Tax on Split Income

shares of a rental property company potentially may qualify as excluded shares for TOSI purposes

2018 STEP Roundtable Q.7 indicated that the shares of a corporation that did not generate business income (e.g., a corporation that generated rents that, given the level of activity, constituted income from property ) cannot qualify as excluded shares, whereas Examples 10 of CRA’s “Guidance on the application of the split income rules for adults” found that dividends received by siblings (now, over 25) following a sale of one of Real Estateco’s rental properties at a gain were from excluded shares, and Example 12 found that Spouse A, aged 65 who owned 95% of the shares of Investco, whose active business was actively managed by Spouse A (with no involvement of Spouse B) before it became a portfolio company, held that 95% bloc as excluded shares. When asked to reconcile Q.7 with the latter two examples, CRA stated:

Example 10 was intended to illustrate the exclusions with respect to reasonable return … and excluded shares. As for Example 12, the latter also covered the exception for excluded shares, but also the deeming rule provided in subparagraph 120.4(1.1)(c)(i) providing relief for spouses of business owners who turned 64 before the end of the year. …

In addition, to demonstrate that the various exclusions were applicable not only to entities that earn income from an active business, such as a manufacturing corporation, but also to entities that carry on a business of earning income from property, such as a property rental business (in Example 10) or an investment management business (in Example 12), we had assumed that these corporations had a sufficient level of activity such that their income could be considered as derived from a business.

5 October 2018 APFF Roundtable Q. 9, 2018-0768801C6 F - Tax on Split

portfolio investment company might qualify as having a business

2018 STEP Roundtable Q.6 and Q.7 confirmed that the shares of a holding company (or of a company generating no business income) cannot qualify as excluded shares, whereas Examples 8 to 12 of CRA’s “Guidance on the application of the split income rules for adults” and the Department of Finance’s “Technical Backgrounder on Measures to Address Income Sprinkling” provide that such shares so qualify. What is CRA’s position? CRA stated:

The CRA's response to [Q.7 ] …was based on the assumption made in the statement of that question that the corporation had no business income. …

…[In its Guidance] … to demonstrate that the various exclusions were applicable … to entities carrying on a business whose principal purpose is to derive income from property, including interest, dividends, rents and royalties, such as investment management corporations (in Examples 8 and 12), the CRA assumed that these corporations maintained a sufficient level of activity such that their income could be considered as derived from such a business.

…[I]f the assumptions in Question 7 were modified so that the corporation carried on a business, the condition in subparagraph (a)(i) of the definition of “excluded shares" in subsection 120.4(1) would be satisfied.

…[I]f it is determined that a corporation does not carry on a business, and that that corporation pays a dividend to a specified individual, the amount of that dividend, provided it does not come directly or indirectly from a related business in respect of the specified individual, could be an excluded amount for the individual.

CRA went on to indicate where Mr. and Mrs. X (both age 35) respectively hold 90% and 10% of the voting common shares of Holdco, whose only source of revenue is dividends on its shares of Opco (wholly-owned by it), which Holdco dividends pro rata to Mr. and Mrs. X, with Mrs. X not being involved in the Opco business, her shares would not be “excluded shares” because “the total income of the corporation would come from another related business in respect of a specified individual (other than a business carried on by the holding corporation).”

However, if Holdco in its preceding year did not receive any dividends from Opco and it holds passive investments (acquired some time ago out of dividends received from Opco) which, in the previous year, generated interest and dividends of $100,000, a portion of which is now dividended pro rata to Mr. and Mrs. X, her shares are “excluded shares” if such $100,000 of income was “derived from the carrying on of a business the purpose of which is to earn interest income and dividends … notwithstanding the fact that the capital used in the acquisition by Holdco of the property used in carrying on its business was derived from dividends received from Opco.” As the dividend received by her would constitute an "excluded amount" under s. (g)(i) of the definition thereof, she would not be subject to split income tax thereon.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (g) - Subparagraph (g)(i) inactive spouse could receive excluded amount dividends from Holdco if its income was from an active business of reinvesting Opco dividends 259

25 May 2018 External T.I. 2018-0761601E5 - Correspondence with XXXXXXXXXX re Tax on Split Income

shares of pizzeria but not hair salon were excluded

A corporation owned 50-50 by two spouses (Family 1) operates a hair salon which derives more than 90% of its income from the provision of services, whereas a second corporation owned 50-50 by two spouses (Family 2) operates a pizzeria that does not derive more than 90% of its income from the provision of services. All are over 25.

CRA indicated that the shares of the corporation operating the pizzeria business will qualify as excluded shares of both spouses, whereas the shares of the other corporation would not so qualify since more than 90% of its income is from the provision of services. CRA stated:

Where a business has income from the provision of both services and non-services (including from a sale of tangible or in some circumstances, intangible property) such as a business carried on by plumbers, mechanics or other contractors that sell replacement parts or materials, the income from the provision of non-services will generally be taken into account in determining whether shares of a corporation are excluded shares of an individual unless such income can reasonably be considered to be necessary but incidental to the provision of the services (for instance an office cleaning service if it billed separately for the cleaning supplies used).

We are in the process of preparing examples to illustrate how the determination of whether less than 90% of the income of a corporation is from the provision of services is made.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (b) no excluded share exception where interposition of family trust or holdco 121
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(ii) where spouse works in only one of two businesses, excluded amount determination requires “separate accounting for each business and a tracing of funds” 158
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) keeping time logs will “ensure that businesses are able to comply with the new rules” 173

8 May 2018 CALU Roundtable Q. 6, 2018-0745871C6 - Tax on Split Income

services/property distinction informed by rationale of the safe harbour exclusions

Mr. X, age 35 year, owns 15% of the shares of Transportco (representing 15% of the votes and value). Transportco earns all or substantially all of its income from a business that sources drivers on contract for logistics companies. Mr. X is not actively involved in the business.

Will s. (a)(i) of “excluded shares” apply such that the shares of Transportco cannot qualify as “excluded shares”? What businesses (e.g., selling life insurance or providing investment products) would be considered to be engaged in the provision of services?

[T]he safe harbour for excluded shares will not apply to the shares of Transportco held by Mr. X by reason of subparagraph (a)(i) of the definition if 90% or more of its business income is from the provision of the services as described in Question 6(a), being the provision of drivers to logistics companies. …

Where the safe harbours do not apply in a particular case, the general underlying rationale is that in such circumstances, the most appropriate test for determining whether the income of a specified individual from a related business should be excluded from split income should be based on the general test of whether the amount received is a reasonable return. …

[I]n most cases, the distinction between whether income is from the provision of services or is other income should be clear. In cases of uncertainty, we will be prepared to provide guidance as required based on a review of all of the relevant circumstances and our understanding of the rationale for the safe harbour exclusions.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (c) shares of a holding company generally do not qualify as excluded shares 153

Paragraph (b)

Administrative Policy

21 August 2018 External T.I. 2018-0771811E5 - 120.4 Excluded Shares

10% of votes and FMV tests can be satisfied on a collective basis

Where a shareholder has non-voting common shares with a fair market value (“FMV”) equal to 20% of the total FMV of the corporation and “skinny” voting preferred shares having a nominal FMV but having 20% of the total votes of the corporation, would the shares be considered excluded shares assuming the tests in paragraphs (a) and (c) of the definition are met? In finding that the 10% of votes and value tests in para. (b) would be satisfied, CRA stated that these:

tests are to be applied at the shareholder level (i.e., based on the aggregate of all classes of shares so owned) versus on each specific class of shares owned by the specified individual.

25 May 2018 External T.I. 2018-0761601E5 - Correspondence with XXXXXXXXXX re Tax on Split Income

no excluded share exception where interposition of family trust or holdco

In confirming that the excluded share exception is available where dividends are paid to a spouse through a holding company (of which the spouse owns more than 10% of the shares) or a family trust deriving all its income from a related manufacturing company, CRA stated:

[I]n the case of a holding company, it will not meet the requirement in paragraph (c) of the definition as all or substantially all of the income would generally be derived from another related business in respect of the individual. In the case of a family trust, the beneficiaries will not meet the requirement in paragraph (b) of the definition as the beneficiaries will not directly own shares of the capital stock of the corporation.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(ii) where spouse works in only one of two businesses, excluded amount determination requires “separate accounting for each business and a tracing of funds” 158
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) keeping time logs will “ensure that businesses are able to comply with the new rules” 173
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (a) - Subparagraph (a)(i) shares of pizzeria but not hair salon were excluded 232

Paragraph (c)

Administrative Policy

9 August 2019 External T.I. 2019-0813021E5 - TOSI and excluded shares

a corporate partner carries on the business of the partnership for TOSI (and other) purposes

Partnership AB, which carries on an active non-services business, is held by two corporate partners (Partnerco A and Partnerco B). The shares of Partnerco A are held as to 10% by Mrs. A and as to 90% by a Holdco for Mr. A and Mrs. A (with 90% and 10% shareholdings, respectively). There is a mirror image structure for Partnerco B (held by directly by Mrs. B as to 10%) and by the Holdco for her (as to 10%) and Mr. B (as to 90%). All four individuals are over 25. Would para. (c) of the excluded shares definition satisfied respecting the 10% shareholdings of Mrs. A and Mrs. B in the respective Partnercos?

CRA responded:

[P]aragraph (c) … will … be satisfied since the related business (i.e. the business carried on by Partnership AB) will also constitute the business of the Partnercos. Where the jurisdictional law regarding partnerships provides that a partnership is an agreement among the partners to carry on business in common, each partner will be considered to be carrying on the business of the partnership. Consequently, the income of the Partnercos will constitute income that is not derived, directly or indirectly, from one or more other related businesses in respect of both Mrs. A and Mrs. B other than a business of the Partnercos.

… Under the assumption that the conditions in paragraphs (a) and (b) of the excluded shares definition are also satisfied, the shares held by Mrs. A in Partnerco A and the shares held by Mrs. B in Partnerco B will accordingly constitute excluded shares.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 96 - Subsection 96(1) - Paragraph 96(1)(f) partner carries on business of partnership 100

12 June 2019 External T.I. 2019-0792011E5 F - TOSI definition excluded shares

two years were required to pass before proceeds from the sale of a related business could generate excluded share income for TOSI purposes

Investco held all the shares of Opco, which was the only related business in respect of the specified individual. In Year X and prior years, Opco (which, like Investco, had a calendar taxation year) paid dividends to Investco. In Year X, Investco sold all the shares of Opco.

Will CRA consider funds thereafter held by Investco and derived from Opco to be derived, directly or indirectly, from a related business in respect of a specified individual for the purposes of the definition of "excluded shares"?

After noting that “under … clause 120.4(1.1)(d)(i)(B) … an amount derived directly or indirectly from a business includes an amount that arises in connection with the ownership or disposition of an interest in the shares of … the corporation that carries on the business, that is, Opco,” CRA indicated that in Year X4, that the specified individual would not be eligible for the excluded share exception respecting a dividend from Investco since, for the last taxation year of Investco, it derived, directly or indirectly, income from a related business in respect of the specified individual by receiving dividends from Opco and also by realizing a capital gain on the Opco share sale (and similarly, in Year X3, dividends were received by Investco in its previous year from the related business).

However:

If, during its X5 taxation year, Investco paid a dividend to the specified individual, the specified individual could benefit from the excluded shares exemption, because, for Investco's last taxation year, Investco did not derive, directly or indirectly, income from a related business in respect of the specified individual (other than an Investco business).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(d) income derived from related business included income from reinvesting sales proceeds from sale thereof in preceding year 112

24 May 2019 External T.I. 2019-0802331E5 - TOSI and excluded shares

“income” references inter alia taxable capital gains of the corporation without deduction for allowable capital losses

Are capital gains “income” under para. (c) “excluded shares,” and are allowable capital losses incurred the year deducted under para. (c)?

After noting its position in 2018-0743961C6 that “income” in para. (c) refers to gross income, being generally that amount which would come into income for taxation purposes, CRA stated that since the “taxable portion of a capital gain from the disposition of property is generally included in the computation of a taxpayer’s income under the Act,” it was such taxable capital gains that were included in applying the substantially all test in para. (c).

As to the treatment of allowable capital losses, CRA stated:

Paragraph (b) of section 3 of the Act refers to, inter alia, the amount by which the total of a taxpayer’s taxable capital gains for the year exceeds the amount of allowable capital losses for the year. In and of itself, this computation is akin to computing net gains (net income) from the disposition of property. In keeping with the intent to consider a taxpayer’s gross income under paragraph (c) … only the amount of taxable capital gains (without any offsetting allowable capital losses for the year) should be included … .

8 May 2018 CALU Roundtable Q. 6, 2018-0745871C6 - Tax on Split Income

shares of a holding company generally do not qualify as excluded shares

Can shares of a holding corporation qualify as “excluded shares”? CRA responded:

The definition of excluded shares should generally not include shares of a holding corporation. This is because, in the case of a holding corporation, all or substantially all of the income would be derived from a related business in respect of the individual (other than a business carried on by the holding corporation).

As a result, the shares of a holding corporation held by a specified individual will not be excluded shares of the individual and any income from, or a taxable capital gain from the disposition of, such shares, will not be an excluded amount and will be split income of the individual and subject to the TOSI unless another exclusion applies.

Depending on the circumstances, the income may not be split income if the income is from a related business that is an excluded business of the specified individual.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (a) - Subparagraph (a)(i) services/property distinction informed by rationale of the safe harbour exclusions 256

Reasonable Return

Administrative Policy

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

auditors should not analyze a reasonable return for TOSI purposes if the taxpayer has made a good faith attempt

Paul Wilson (Director, Medium Business Audit Division, Small and Medium Enterprises Directorate) elaborated on the statement in 2018-0771851E5 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... .”

Auditors are instructed to, first, question the taxpayers to determine what steps they took to verify that there was or was not split income, and if there has been a good faith attempt, then the auditors do not need to question further. Thus, if there are no other issues raised by the facts, the Directorate would accept a taxpayer’s good faith attempt. If there is a grey area, it might prefer to educate the taxpayer rather than assess.

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

11 October 2019 APFF Roundtable, Q.18

potential application of reasonable return exception where on mat leave or disability

A specified individual, who holds only 5% of the shares of Aco has however been “actively engaged on a regular, continuous and substantial basis” (“Involved”) in the active business of Aco (which is run by her husband) for 2017 through 2019, so that the dividends received by her on her shares of Aco were excluded amounts and, thus, not subject to the tax on split income. If throughout 2020 she were absent from any work because of a maternity leave or temporary (or permanent) disability, would her dividends still be excluded amounts?

CRA indicated that, indeed, the excluded business exception from TOSI would be unavailable in 2020 because she had no involvement in the business. (CRA implicitly found that she could not rely in that year on para. (b) of the excluded business definition, because she had only been Involved for a total of three rather than five prior taxation years.)

CRA went on to indicate that the reasonable return exception might be available, noting that any application of this exclusion would be:

based on the specific criteria applicable in the circumstances, including the work performed, the property contributed, the risks assumed, the total amounts paid or payable and such other factors as may be relevant.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Business - Paragraph (a) loss of excluded business exception when specified individual went on extended mat leave or disability 310

7 August 2019 External T.I. 2019-0814161E5 - Application of Reasonable Return - TOSI

shares subscribed for out of a joint bank account should not be treated as having been funded by a passive spouse in applying the reasonable return TOSI exception

Spouses A and B are among the beneficiaries of a discretionary family trust holding Holdco which, in turn, holds Opco in whose business Spouse B (quite unlike Spouse A) has no involvement. The shares of Opco had been issued to Spouse A for cash subscription proceeds that came out of a joint bank account of Spouses A and B. Dividends are paid from Opco to Holdco, and by Holdco to the trust, which designates taxable dividends equally to Spouses A and B. Does the “reasonable return” exception in “excluded amount” preclude the dividends designated to Spouse B from being split income?

After noting that such dividends would be split income, unless the “reasonable return” exception in s. (g)(ii) of “excluded amount” applied, CRA stated:

[A]lthough the cash used to fund Spouse A’s initial share investment … was stated to be from cash that came from a joint account … the legal form of these transactions strongly suggests that Spouse B has not made any direct or indirect contribution of property to Opco. However, this is a mixed question of fact and law … .

…[T]aking an overly broad interpretation that a specified individual has made an indirect financial contribution to a business such that the reasonable return exception in subparagraph (g)(ii) of the definition of excluded amount would apply to prevent the amount from being split income would appear to frustrate the underlying tax policy of the TOSI rules.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (g) - Subparagraph (g)(ii) broad construction of reasonable return exception would violate TOSI policy 219

2 November 2018 External T.I. 2018-0771851E5 - TOSI: Meaning of Reasonable Return

subsequently eliminated start-up risk can be taken into account/retained earnings irrelevant/CRA does not substitute its judgment

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.

1. Notwithstanding such repayment, can Mr. X continue to look to the reasonable return exception having regard to the risks he initially assumed on the start-up of XCo’s business?

2. Can Mr. X look to the undistributed retained earnings of XCo as capital that is at risk for purposes of the reasonable return exception, assuming that he did not receive any dividends?

Respecting Q.1, 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). …

[T]he 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 … .

Re Q.2:

The focus of the inquiry into whether an amount is a reasonable return in respect of a specified individual is on the relative contributions of the specified individual and each source individual in respect of the specified individual. Since the undistributed retained earnings of XCo would not, in the scenario presented above, represent capital contributed directly or indirectly by either Mr. X or Mrs. X, the existence of such undistributed retained earnings would not be relevant in assessing their relative contributions to the related business carried on by XCo.

Guidance on the application of the split income rules for adults 15 December 2017 CRA Webpage

Deference to taxpayer’s good-faith efforts to determine Reasonable Return

In determining whether the payment is a Reasonable Return [defined as a reasonable return based on listed criteria or “such other factors that may be relevant” (the "Reasonableness Criteria")], 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.

Example 2 (high interest on start-up loan)

Proposals do not apply to age-25 child with start-up restaurant company who borrows at the same high interest rate from mother and friends.

Example 5C (over 24 and dividend comparable to reasonable salary)

An Opco dividend distributed by family trust to grandchild (over 24) working one day per week in Opco business, where the distribution’s amount is the same as the amount paid by Opco to its full-time clerical staff prorated for the time worked by the grandchild.

Example 7 (child acquiring Opco receives large dividend before exceeding hours test)

Parent who worked full-time in the business of Opco, which is a small business corporation, retires and sells all the shares of Opco to Child (over 25), who now manages the business, but does not meet the 20 hour average test because the sale occurred part-way through the year. A large dividend paid to Child at year end is an excluded amount because Child is actively engaged in the business and because the dividend represents a reasonable return.

Example 10 (dividend of over-25s on gain from jointly supervised real estate)

Siblings A, B and C founded Real Estateco with nominal capitalization and built it up through 3rd-party financing (using personal guarantees) and a 3rd-party manager. Dividends received by them (now, over 25) following a sale of one of Real Estateco’s rental properties at a gain is from excluded shares and also represents a reasonable return “having regard to the risks they assumed as directors of Real Estateco, their supervision of Third Party and their involvement in Real Estateco’s strategic decisions.”

Example 11 (not unreasonable dividend to bookkeeper-spouse working under 20 hours for Professionalco)

As the spouse (over 25) of a full-time professional works less than 20 hours per week on her bookkeeping functions constitute a reasonable return. “While high, the amount of the dividend is comparable to the amount that was paid to an arm’s length person.”

Paragraph (b)

Articles

Govindadeva Bernier, Tim Scholz, "Income Sprinkling Using Private Corporations", Office of the Parliamentary Budget Officer (with thanks to “Finance Canada officials for their helpful technical discussions”), 8 March 2018

Preferred scenario assumes that all spouses aged over 24 are earning a reasonable return (pp. 1-2)

The Parliamentary Budget Officer (PBO) … computed possible revenue outcomes for the government based on three different scenarios.

In all three scenarios, we considered dividends paid to adult family members as not being subject to the TOSI, for individuals where:

  • the employment income based on the T4 slip issued by a family owned- CCPC was above a $15,000 threshold;
  • if they were 25 years of age or older, they owned at least 10 per cent of the shares of a family- owned CCPC that was not in the service or professional sector;
  • they were the spouse of a primary owner aged 65 or over.

Scenario 1

In this scenario, we also excluded all the spouses aged 25 or over from being subject to the new TOSI rules. The rationale behind this scenario is that it is likely that most spouses have assumed some risk in the family business (for example, using the house as collateral for a bank loan to start the business). Therefore, we assume they would pass the reasonableness test and see the dividends they received as being exempt from the TOSI. This is our preferred scenario. …

Kevyn Nightingale, "Private Company Income-Splitting Proposal Part 3: The Government Responds", Tax Topics (Wolters Kluwer), No. 2389-90, December 21, 2017, p. 1

Intractability of linking business income/gains to individual contribution (p. 3)

Business income and gains are inherently different from employment income, investment income, or even payments to outside contractors. Returns are random, often yielding unintended results, from large gains to bankruptcy. There's often no demonstrable way to connect the results back to the contributions of specific people. The notion that one can do so is closely related to the 18th-century (and later Marxist) labour theory of value – an intuitive notion that has since been thoroughly debunked in the economic literature.

Inability to align actual capital gains split to avoid TOSI (p. 3)

Consider the simplest scenario: two spouses go into business together. The corporation issues them equal amounts of the same class of common shares. They work together for some time. Eventually, one spouse takes some time off for child-rearing, sickness, or some other reason. The other works more. Suppose one could say that over the time of ownership, one spouse was 60 per cent responsible for the success of the company, and the other 40 per cent. The shares are then sold at arm's length. The spouses each realize 50 per cent of the total gain. In this scenario, 20 per cent of one spouse's gain is split income, and taxed at the highest rate. There is no way around this, except to manipulate the price paid by the vendor to each spouse. That tax-guided manipulation may not be acceptable, or even possible because of the attribution rules.[f.n.: 15: E.g., ITA s.74.1(1).]

Onerous information tracking (p. 4)

The proposal requires tracking of a minor's income past his age of majority. Certain "Secondary income" – derived from income previously subject to attribution – will be subject to TOSI. This requires lifetime tracking of capital acquired as a minor.

Even when records exist, they would need to be retained for decades. In the normal course, for practical reasons, we properly limit the records that must be maintained beyond six years. [Fn 16: ITA s. 230(4)-(7), Reg. 5800, IC 78-10R5 Para. 24-29.]

Income may be earned by a business in one year, and paid out much later. Where the company is sold, it may be necessary to track the gain to decisions made years earlier. Upon death of a shareholder, a beneficiary is deemed to provide the contributions made by the decedent. The decedent's contributions are thus relevant for potentially decades more.

De facto penalty where income not otherwise top-rate income (p. 4)

If people realize income or gains subject to these rules, they are subject to tax at the top tax rate. The basis for this treatment is that it should have been taxed in someone else's hands. However, this treatment applies even where the "right" person's tax rate is lower than that. In effect, it can be a penalty.

Finance

Preferred scenario assumes that all spouses aged over 24 are earning a reasonable return (pp. 1-2)

The Parliamentary Budget Officer (PBO) … computed possible revenue outcomes for the government based on three different scenarios.

In all three scenarios, we considered dividends paid to adult family members as not being subject to the TOSI, for individuals where:

  • the employment income based on the T4 slip issued by a family owned- CCPC was above a $15,000 threshold;
  • if they were 25 years of age or older, they owned at least 10 per cent of the shares of a family- owned CCPC that was not in the service or professional sector;
  • they were the spouse of a primary owner aged 65 or over.

Scenario 1

In this scenario, we also excluded all the spouses aged 25 or over from being subject to the new TOSI rules. The rationale behind this scenario is that it is likely that most spouses have assumed some risk in the family business (for example, using the house as collateral for a bank loan to start the business). Therefore, we assume they would pass the reasonableness test and see the dividends they received as being exempt from the TOSI. This is our preferred scenario. …

Related Business

Administrative Policy

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

low threshold for determining whether there is a business for TOSI purposes

Paul Wilson (Director, Medium Business Audit Division, Small and Medium Enterprises Directorate) provided comments noted below on the following scenarios:

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.

Mr. Wilson commented that, based on prior rulings and the 2018 STEP Roundtable, the Directorate’s auditors would simply consider the income to be from property, given that the only activity was passive income generation from the GIC. Thus, the excluded share exemption would not be met, but there would be 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.

Mr. Wilson noted that although the interest would probably be income from property, as for the dividend income, given that the Rulings Directorate and the courts have indicated a very low threshold for when a corporation has a business, the corporation would likely be considered to have a business.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (a) - Subparagraph (a)(i) quaere whether low-service hotel business is a services business 392

11 June 2019 External T.I. 2019-0795291E5 F - Tax on Split Income - 120.4(1) excluded amount

no TOSI tax applied to a dividend received from the surviving step-mother’s company

In 2018, following his marriage to Ms. B, who was not the mother of his 33-year old son (Son A), Mr. A died. Mr. A bequeathed all of the common shares of Opco (a CCPC in whose business he had been actively engaged on a regular, continuous and substantial basis), to Ms. B, who was also so engaged both before and after his death. In 2019, Opco paid a dividend on the discretionary dividend shares of its capital stock held by Son A. Was that dividend subject to the tax on split income?

CRA noted that following the death of Mr. A, he was no longer Ms. B's spouse and, therefore, Son A no longer qualified as Ms. B's child under s. 252(1)(c) – and they would not otherwise be related. Since she was now unrelated, Ms. B would not be a "source individual" (as defined in s. 120.4(1)) in respect of the specified individual (i.e. Son A). Thus, Opco's business would not constitute, in respect of Son A, a "related business," as ss. (a)(ii) and (c)(i) of that definition would not be satisfied. CRA concluded:

Since the Opco business would not be a "related business" in respect of Son A, Son A could benefit from the "excluded amount" exclusion in subparagraph 120.4(1)(e)(i).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(i) dividend received from widowed step-mother's company was not re a related business 130

Paragraph (a)

Subparagraph (a)(i)

Administrative Policy

5 October 2018 APFF Roundtable Q. 11, 2018-0768821C6 F - Tax on Split Income

stock market investing business of child's holdco not a related business as father not involved

All the voting shares of Opco are held by Mr. X and all its participating shares are held by a family trust (“Trust”). In the prior year, Holdco, which is wholly-owned by Child X (age 35, who is not involved in the Opco business) generated $150,000 of passive income, and also received qua beneficiary a $100,000 distribution of a dividend that Trust had received from Opco. Could Holdco now pay a $75,000 dividend (the “Dividend”) on the basis that it was derived from income on the stock market investments rather than from Opco, so as to avoid the split income tax?

CRA concluded that “Holdco must adequately monitor its funds derived from stock market investments in order to determine whether those funds were used to pay the Dividend.” Split income tax would apply if the Dividend came “out of the funds from the $100,000 dividend received from Opco or from any dividends previously received from Opco.”

On the other hand “if it can be determined that Holdco will pay the Dividend to Child X out of its after-tax income from its stock market investments, then that dividend would be an excluded amount for Child X and would not be included in calculating the child’s split income.” There were two possibilities in this regard. First, the stock portfolio of Holdco might represent an investment “business,” in which case it would not be a “related business” because Mr. X (the father) was not involved in this business. Alternatively, if it was not a business, then it would again follow that it could not be a related business. Thus, either way, the stock portfolio would represent a good source for the Dividend that would not engage the tax on split income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(i) dividends derived from stock portfolio of Holdco excluded because stock portfolio not a related business or not a business 435

Subparagraph (a)(ii)

Administrative Policy

3 December 2019 CTF Roundtable, Q.9

source individual status retained after arm's length sale if continued active involvement in business

A specified individual (the “Individual”) receives a dividend paid out of corporate income that is derived, directly or indirectly, from a related business that was carried on by the Corporation in prior years, but which is no longer carried on by it. The Corporation did not derive, directly or indirectly, income from a related business in respect of the Individual other than the previously carried-on related business. Would the dividend be an “excluded amount” where:

(a) The business ceased in a prior year, and is no longer operated by anyone.

(b) The business was sold to an unrelated corporation in a prior year and is still active, but no source individual in respect of the dividend recipient was active in the business in the year of the dividend.

(c) The business was sold to an unrelated corporation in a prior year and is still active, but a source individual in respect of the dividend recipient was active in the business in the year of the dividend (for example, a former owner related to the Individual is employed by the new owners in the business, perhaps for a transitional period).

CRA responses

(a) In this scenario, the income was not derived from a related business for the year because the business was not carried out in the particular year, so that the dividend is an “excluded amount.”

(b) Although the business is still carried on, it was sold to an unrelated corporation in a prior year, so that there is no source individual actively engaged in the year of the dividend. Accordingly, the dividend received by the individual in that subsequent year would not be considered to have been derived from a related business for the year, so that the dividend would be an “excluded amount.” and would not be subject to TOSI.

It is assumed that the source individual would no longer retain any ownership in the business. If that is not the case, para. (c) of the definition of “related business” could apply.

(c) Where the business is sold to another unrelated corporation in a prior year yet still carried on, and the source individual is active in the business in the year of the dividend, then the business carried on by the unrelated corporation will constitute a related business for the year. Thus, the business carried on by the unrelated corporation will constitute a related business until the source individual is no longer actively engaged in the activities of the unrelated corporation.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(i) a transitional services agreement with an arm’s length purchaser can engage the TOSI rules 84

3 December 2018 CPA Canada Roundtable, 2018-0773811C6 - Tax on Split Income (TOSI)

dividend paid to unrelated active shareholder

Example III: Income not from a related business (pp. 23-24)

B, aged 20, was issued 20% of the shares of Opco (a CCPC) as part of his compensation for programming work. Opco is majority-owned by an unrelated individual (A, aged 40). A dividend paid by Opco to B is not subject to TOSI given that it is not income from a related business because there is no “source individual” (A is not related to B).

5 October 2018 APFF Financial Strategies and Financial Instruments Roundtable Q. 3, 2018-0765801C6 F - Tax on Split Income

related business if children manage investment business of trust whose interest income is distributed to mother

Jean on his decease left proceeds of an insurance policy and non-registered investments (which had been acquired by him out of accumulated savings) under a trust (“Trust”) for the exclusive benefit of his surviving spouse (“Jeanne,” also a Canadian resident), and with two of their children as trustees. Is the income generated by Trust and distributed to Jeanne subject to the tax on split income where the Trust investments are managed by: the two trustees; an independent third party; or a child of Jean and Jeanne who is not a Trust beneficiary but is a stock broker?

After assuming that Trust's investment income consists of taxable dividends on shares listed on a designated stock exchange ("Dividends"), taxable capital gains from the disposition of such shares ("Capital Gains") and interest on debt obligations ("Interest"), and after finding that the distributed Dividends and Capital Gains were not split income by virtue of the ss. (a)(i), (c)(ii)(A) and (e)(ii)(A) exclusions in the “split income” definition, CRA went on to consider whether the distributed Interest would be split income to Jeanne in the absence of the exclusion in s. 120.4(1.1)(c)(ii). On this basis, CRA first found that the distributed Interest would not constitute income from a “related business” (as per s. (a)(ii) of the definition) if Trust did not carry on business. After noting that Jeanne’s children were source individuals in respect of Jeanne, CRA went on to state that:

If it were … established that Trust is carrying on a business and that, under any of the scenarios contemplated in the question as stated, a source individual in respect of Jeanne is actively engaged on a regular basis in the activities of Trust related to earning income from the business, then the portion of the Distribution related to the Interest would come, directly or indirectly, from a related business in respect of Jeanne for the purposes of the application of clause (c)(ii)(C) of the definition of "split income" in subsection 120.4(1).

In the final version of its answer, CRA further noted:

Even assuming that Jean derived income from a business from these properties, this business could not qualify as a related business in relation to Jean.

Indeed, by virtue of subparagraph (a)(i) of the definition of "related business" in subsection 120.4(1), the business carried on by an individual must be carried out by a source individual in respect of the specified individual. Since Jean cannot be a source individual in relation to himself, the hypothetical business could not be a related business in respect of Jean.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Split Income - Paragraph (e) - Subparagraph (e)(ii) deemed s. 104(21) capital gains retained their character as stock market gains 177
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(c) - Subparagraph 120.4(1.1)(c)(ii) s. 120.4(1.1)(c)(ii) exclusion where investment portfolio business of spousal trust had been carried on directly by deceased husband 322

Paragraph (c)

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Valuation difficulties where shares of Opco are held through a trust (p. 13)

  • Para. (c) of “related business” looks at whether a specified individual owns shares or “property that derives, directly or indirectly, all or part of its fair market value from shares…” exceeding the 10% relative valuation threshold, its application will be unclear \where the shareholder of the corporation is a trust.
  • The capital beneficiaries of the trust own a beneficial interest in the trust property, which should be considered “property”. “Even if the value of a beneficiary’s capital interest can be determined, it will be a difficult to determine what portion of the fair market value of that interest is derived from the shares of the corporation.”

Failure to exclude public corps and mutual funds (p. 13)

  • The definition of “related business” does not exclude listed corporations or mutual fund trusts or corporations.
  • For example, a specified individual is a beneficiary of a trust holding shares of a listed arm’s length corporation of which a Canadian-resident sibling is a full-time employee, such that this public corporation is carrying on a “related business” in respect of the specified individual, and so that any income or taxable capital gain of the specified individual included under s. 104(13) or 105(2) in respect of the trust would seem to be subject to TOSI.

Uncertainty as to tainting effect of a deceased source individual (p. 16)

Where a business used to be operated by a source individual who is now deceased, it is uncertain whether the business will remain a “related business”, or whether the income from such business going forward will still be considered “derived directly or indirectly from a related business”.

Subparagraph (c)(i)

Clause (c)(i)(B)

Administrative Policy

5 October 2018 APFF Roundtable Q. 10, 2018-0768811C6 F - Related business and subsection 120.4(1)

beneficial interests in discretionary trusts holding shares of a corporation with a mooted related business must be valued

The definition of “related business” – (c)(i)(B) references a business of a corporation where a source individual owns property “that derives, directly or indirectly, all or part of its fair market value” from shares of the corporation. What are examples of such property; and is an interest in a trust “property” for such purposes even if the trust is entirely discretionary? CRA responded:

The property referred to in clause (c)(i)(B) of the definition of "related business" in paragraph 120.4 may include, inter alia, shares of the capital stock of a corporation, interests in a partnership or interests in a trust. …

An interest in a trust is property for the purposes of the definition of "related business" in subsection 120.4(1), regardless of whether the trust is a wholly discretionary or non-discretionary trust.

Furthermore, the determination of the FMV of an interest in a discretionary trust is a question of valuation.

Split Income

Administrative Policy

Paragraph (a)

Subparagraph (a)(i)

Administrative Policy

7 June 2019 STEP Roundtable Q. 14, 2019-0798511C6 - TOSI and PBE

subjecting dividend income paid to a preferred beneficiary to TOSI accords with tax policy – but the designation can be readily avoided

The Summary portion of 2018-0759521E5 indicated that if a s. 104(19) designation is made respecting a preferred beneficiary income amount resulting from an election under s. 104(14), the amount would be includable in split income under para. (a) of that definition. Can CRA (i) elaborate on its reasoning in this regard, (ii) confirm its position respecting minor preferred beneficiaries for years prior to 2018, and (iii) indicate how a T3 return should be prepared to avoid a s. 104(19) designation when allocating a taxable dividend to a preferred beneficiary?

CRA indicated that, as noted in Q.13, the exception in s. (a)(i) from the para. (c) exclusion for taxable dividends designated under s. 104(19) reflects the absence of a legislative exclusion from the tax on split income for such dividends, is consistent with 2000-0056385 F, and has been noted in the T3 guide every year since 2000 (page 44 of the 2018 guide). This issue has been discussed with the Department of Finance, and CRA’s interpretation on this matter is consistent with tax policy, so that CRA will not be granting relief for any historical preferred beneficiary elections made.

In order to avoid making the s. 104(19) designation when preparing a T3 slip, the amount should simply be included in Box 26 (“other income”).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 104 - Subsection 104(19) designation can be avoided by including dividend in "other income" box 102

7 June 2019 STEP Roundtable Q. 13, 2019-0798501C6 - TOSI and PBE

no exclusion for dividend income flowed out to preferred beneficiary

Para. (c) of the “split income” definition refers to amounts included in a beneficiary’s income under s. 104(13), but not under s. 104(14) as a result of a preferred beneficiary election.

CRA noted however that s. (a)(i) of the split income definition provides for the inclusion of taxable dividends received by the specified individual in respect of the shares of the corporation (other than listed or mutual fund shares). Thus, if the income allocated to a preferred beneficiary is also subject to a s. 104(19) designation, the designated amount will be included in the beneficiary’s split income, unless one of the TOSI exceptions applies.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Split Income - Paragraph (c) exclusion inapplicable to dividend income flowed through to a preferred beneficiary 162

5 October 2018 APFF Roundtable Q. 12, 2018-0768831C6 F - Tax on Split Income and Partnership

family partnership investing in designated stock exchange shares not subject to TOSI rules

The five partners of a family partnership that generates and distributes passive income from stock market investments are Mr. and Mrs. X and their Children X, Y and Z ages 15, 22 and 23, respectively. The children have not contributed to or been involved in the management of the partnership, whereas Mr. and Mrs. X have been so involved in the sense of communicating four times per year with their stock broker. Is the partnership income subject to the tax on split income?

CRA indicated that such tax was inapplicable given that "split income" – para. (a) excluded dividends on listed shares or of mutual fund corporations, and para. (e) excluded taxable capital gains realized on such shares – and given that under s. 96(1)(f), partnership income retained its nature and character when allocated to the partners.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 103 - Subsection 103(1.1) having non-contributing children as members of a family stock market partnership is subject to challenge under s. 103 81
Tax Topics - Income Tax Act - Section 96 - Subsection 96(1.8) having non-contributing children in a family portfolio investment partnership subject to potential challenge under ss. 74.1 and 96(1.8) 89

Articles

Stan Shadrin, Manu Kakkar, Alex Ghani, "FAPI and TOSI Overlap: 107 Percent Tax is Not Fair", Tax for the Owner-Manager, Vol. 20, No. 1, January 2020, p.5

Example of dual (s. 95(2)(b)) FAPI and TOSI

Mr. A and Ms. B own 50% each of the shares of Passive Foreignco and of the shares (having a nominal ACB) of Active Foreignco, which earns active business income (in a Treaty country with a 0% tax rate), but provides services to Passive Foreignco, which has no net investment income.

The fees for Active Foreignco’s services to Passive Foreignco are deductible from Passive Foreignco’s FAPI.

The shares of Active Foreignco are not excluded shares because Active Foreignco is a service business.

FAPI under s. 95(2)(b) (p. 6)

The fees for the services of Active Foreignco will be considered deductible in the FAPI calculation of either Mr. A or Ms. B (because they will be deductible from the investment income of Passive Foreignco). Thus, pursuant to paragraph 95(2)(b), the income of Active Foreignco from such services will be deemed to be income from a separate business other than an active one… . Therefore, that income will result in a FAPI addition to the incomes of Mr. A and Mrs. B in respect of their shares of Active Foreignco.

Second level of tax under TOSI rules (p. 6)

[T]he dividends paid to Mr. A or Ms. B from Active Foreignco will be considered split income of Mr. A or Ms. B. Because the dividends are subject to the TOSI rules, the incomes of both Mr. A and Ms. B will be reduced to nil pursuant to paragraph 20(1)(ww). Since their incomes are already nil, a deduction pursuant to subsection 91(5) will not be beneficial.

Therefore,…double taxation is likely to arise: the income will be taxed as FAPI and the dividends will be taxed under the TOSI rules. Assuming that FAPI is taxed at a rate of 53.53 percent (Ontario’s highest rate) and the dividends are taxed under the TOSI rules at the same rate, the combined tax on such income will be 107.06 percent.

It is uncertain whether any relief would be provided in the situations described above pursuant to subsection 248(28),…

Paragraph (c)

Administrative Policy

7 June 2019 STEP Roundtable Q. 13, 2019-0798501C6 - TOSI and PBE

exclusion inapplicable to dividend income flowed through to a preferred beneficiary

Is an amount, included in a beneficiary’s income under a preferred beneficiary election, split income under para. (c) of the “split income” definition, which refers to an amount included under s. 104(13) or 105(2), but not s. 104(14)?

CRA indicated that because the amount of income that is designated under the preferred beneficiary election is included in the individual’s income under s. 104(14) and not because of the application of s. 104(13) or 105(2), para. (c) of the “split income” definition is inapplicable.

However, s. (a)(i) of the split income definition provides for the inclusion of taxable dividends received by the specified individual in respect of the shares of the corporation, other than shares of a class listed on a designated stock exchange or shares of a mutual fund corporation. Thus, if the income allocated to a preferred beneficiary is also subject to a s. 104(19) designation, the designated amount would be included in the specified individual’s split income, unless one of the exceptions applies.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Split Income - Paragraph (a) - Subparagraph (a)(i) no exclusion for dividend income flowed out to preferred beneficiary 104

6 July 2018 External T.I. 2018-0759521E5 - Tax on split income & preferred beneficiary

income to preferred beneficiary is not split income

A trust that is a limited partner of a partnership (“LP”) providing back office support to a general partnership of accounting professionals (“Partnership”) as its only source of income has a minor disabled beneficiary who qualifies as a “preferred beneficiary.” Does the definition of “split income” include income of the trust allocated under s. 104(14) to that beneficiary? CRA stated:

[T]he income allocated to a preferred beneficiary under subsection 104(14) in the fact scenario you have provided is not included in the definition of split income and therefore is not subject to tax on split income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 104 - Subsection 104(14) split income rules do not apply to preferred beneficiary income 87

10 March 2014 Internal T.I. 2013-0493971I7 F - Application of section 120.4

LP income not from property provision or services

X "split" his professional income with a limited liability partnership (SENCRL) of which one of the partners was a trust for the benefit of related minors.

The pre-2014 version of the split income definition did not apply "due to the fact that the income of the [SENCRL] or of the trust was not derived from the provision of property or services" [TaxInterpretations translation].1) - split income - (c) However,

the addition of clause (c)(ii)(D)…appears to suggest the intention of the Department of Finance to rectify the scope of what is included under section 120.4 in situations such as described here. … [T]he addition…could solve the problem in this case, but only for the 2014 and subsequent taxation years.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 103 - Subsection 103(1.1) allocation of income to partner not responsible for expenses 177
Tax Topics - Income Tax Act - 101-110 - Section 103 - Subsection 103(1) income-splitting partnership terms 146

11 October 2013 APFF Roundtable, 2013-0495651C6 F - Revenu fractionné

streaming of non-split income to child discretionary beneficiary and split income to mother

A discretionary family trust with Father, Mother and a 15-year old Child as beneficiaries, holds a building with two premises – the first leased to an arm's length tenant; and the second, to a professional corporation of Father and Mother. Could the split income tax be avoided if the trust distributed only the income from the first premises to Child, and the income from the second premises to Mother? In concluding (per the summary) "Yes, when the trust indenture allows such attribution [sic, allocation and distribution]," CRA stated (TaxInterpretations translation):

In some instances, the deed of trust permits the allocation to two separate beneficiaries of the income derived from a building, so that one portion of the income, which complies with the conditions in clause (c)(ii)(C) of the "split income" definition in subsection 120.4(1), can be distributed to a specified individual even though the other portion of the income does not so comply. In such a situation, we are of the view that only the part of the income distributed to a specified individual that it is reasonable to consider as income described by clause (c)(ii)(C)of the definition of "split income" in subsection 120.4 would be considered as "split income" for the purposes of subsection 120.4(1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 104 - Subsection 104(13) streaming of split and non-split income between trust beneficiaries 94

Articles

Joseph Frankovic, "Income Splitting and Attribution", Tax Topics, Wolters Kluwer, No. 2250, April 23, 2015

[T]he rules were introduced in 2000 in response to certain tax planning scenarios that circumvented the income attribution rules and were sanctioned by the courts (e.g., Ferrell, 99 DTC 5111 (FCA)).

Split income includes dividends and taxable shareholder benefits received from a corporation, either directly or through a trust or partnership, but not including dividends from a corporation whose shares are listed on a designated stock exchange or a mutual fund corporation. Additionally, in response to certain schemes under which minor children would sell their shares to their parents (or other non-arm's length persons) as a way of avoiding the split income tax (and potentially claiming the capital gains exemption), amendments introduced in the 2011 federal Budget provide that the amount of a minor child's taxable capital gain from a disposition of shares to a non-arm's length person is deemed not to be a taxable capital gain, and twice the amount is deemed to be a dividend that is not an eligible dividend. The split income tax on dividends can therefore apply.

Subparagraph (c)(ii)

Clause (c)(ii)(C)

Administrative Policy

Guidance on the application of the split income rules for adults 15 December 2017 CRA Webpage

Example 1 (trust distribution to inactive under-25 child)

Opco dividend distributed by discretionary family trust to age-23 child who never worked in business is split income.

Example 6 (dividends following estate freeze)

Following Parent A (who previously had worked full-time in the business) effecting an estate freeze on Opco, his preferred shares will be redeemed over time, Child 1 (over 25) who works in the business over 20 hours per week will receive salary and Child 2 (also over 25) who does not work in the business and is employed elsewhere will receive, along with Child 1, distributions by a family trust of Opco dividends.

The deemed dividends received by Parent 1 are from an excluded business given Parent 1’s previous full-time work. Child 1’s trust distributions are excluded amounts but not those of Child 2 – but as Child 2 is in the top bracket, no additional tax will be paid.

28 March 2012 External T.I. 2011-0422531E5 F - Revenu fractionné

only a portion of s. 104(13) income might be split income

How is "split income" determined where, in a particular taxation year, a portion of the amount included in the income of a beneficiary of a trust under s. 104(13) satisfies the conditions for the application of clause (c)(ii)(C) of the definition while another portion does not? CRA responded:

Section 120.4 does not provide a rule for pro-rating income. Therefore, all facts must be analyzed to determine whether a portion of an amount allocated to a beneficiary of a trust is split income … .

Where, in a particular taxation year, a portion of an amount included in the income of a beneficiary of a trust by virtue of subsection 104(13) satisfies the conditions for the application of clause (c)(ii)(C) … while another portion does not satisfy those conditions … only that portion of the amount that meets [those] conditions … must be included in the calculation of split income for that beneficiary.

Clause (c)(ii)(D)

Administrative Policy

5 October 2018 APFF Financial Strategies and Instruments Roundtable Q. 4, 2018-0765811C6 F - Tax on Split Income

no TOSI on net rental income of spousal trust on properties managed by son if excluded amounts

A spousal trust for Jocelyne (“Trust”) holds five commercial rental properties (generating $250,000 in annual rents, which had been managed by her deceased husband). Is the income generated by Trust and distributed to Jeanne subject to the tax on split income where the Trust investments are managed by: Jocelyne’s son Julien who, as the sole trustee, manages the properties (e.g., repairs, rent collections, accounts); and Julien not as trustee but as Trust employee; and Julien, as neither.

CRA noted that the net rental income distributed to Jocelyne would come within s. (c)(ii)(D) of the definition of "split income" if “it was established that Julien actively engages on a regular basis in the activities of Trust” and that it also could be included under s. (c)(ii)(D ) – except that by virtue of s. (e)(i), the distribution would be an excluded amount if it was not derived directly or indirectly from a related business in respect of Jocelyne.

However, even if the distribution were not otherwise an excluded amount, it would likely be excluded under s. 120.4(1.1)(c)(ii).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(c) - Subparagraph 120.4(1.1)(c)(ii) exclusion where rental portfolio of spousal trust was a directly-conducted business of deceased husband 302

9 October 2015 APFF Roundtable Q. 2, 2015-0595521C6 F - Meaning of "actively engaged"

IT-349R3 and IT-268R4 potentially relevant to meaing of "actively engaged on a regular basis"

The reference in (D) of the "split income" definition to "actively engaged on a regular basis" can reasonably be considered to be partly informed by judicial and CRA interpretations (e.g., in IT-349R3 and IT-268R4) accorded to the phrase "actively engaged on a regular and continuous basis" in provisions (e.g., s. 70(9)) dealing with farming or fishing businesses, as well as in the somewhat similar "specified member" definition in s. 248(1).

Paragraph (d)(i)

Administrative Policy

11 October 2019 APFF Roundtable, Q.15

beneficiaries of a family trust can benefit from the excluded debt exception from the TOSI rules

S. (d)(i) of the s. 120.4(1) “split income” definition excludes an amount in respect of a debt obligation of a mutual fund corporation or trust or of a corporation whose shares are listed on a designated stock exchange (an “Excluded Debt”). If the sole asset held by a trust is an Excluded Debt, would the interest thereon that is included in a beneficiary’s income under s. 104(13) be in respect of an Excluded Debt?

CRA first noted that the preamble to the s. 108(5)(a) rule excluded its application to s. 120.4, and stated: “Thus, for the purposes of section 120.4, the character of the amounts allocated by a trust will be maintained.” CRA then stated:

The wording of the preamble to paragraph (d) of the definition of "split income" in subsection 120.4(1) includes the words "in respect of", which are very broad in scope. … [T]his subsection can apply to an amount of interest received from a trust and included in computing the income of a specified individual, to the extent that all other conditions for application of that paragraph are satisfied. However, where the amount of interest is in respect of an excluded obligation held by a trust, such amount does not constitute split income of a specified individual.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - 101-110 - Section 108 - Subsection 108(5) - Paragraph 108(5)(a) source character of trust income maintained in the absence of s. 108(5)(a) appplication 52

Paragraph (e)

Articles

Martin Lee, Manu Kakkar, Thanusan Raveendran, "Section 48.1: TOSI Trap in Going Public", Tax for the Owner-Manager (Canadian Tax Foundation), Vol. 20, No. 1, January 2020, p. 4

Potential desirability of making s. 48.1 election even where shares are not QSBC shares (p. 4)

Capital gains arising from a disposition of shares that are qualified small business corporation (QSBC) shares are not subject to TOSI. …

There are times when it is tax-advantageous to trigger a capital gain under subsection 48.1(1) even if the shares are not QSBC shares—for instance, to utilize tax attributes such as expiring losses.

Potential for TOSI where making s. 38.1 election (p. 5)

Under the new rules, taxable capital gains subject to TOSI are no longer limited to transactions under the purview of subsections 120.4(4) and (5). … [T]he expanded definition of "split income" includes taxable capital gains from the disposition of all non-QSBC private corporation shares realized, or deemed to be realized, by most Canadian residents. Thus, it may no longer be beneficial to trigger a capital gain under subsection 48.1(1) when the shares do not qualify as QSBC shares in the situation discussed above, unless one of the other excluded-amount exemptions applies.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 48.1 - Subsection 48.1(1) TOSI rules have resulted in the s. 48.1(1) election being less frequently desirable 138

Subparagraph (e)(ii)

Administrative Policy

5 October 2018 APFF Financial Strategies and Financial Instruments Roundtable Q. 3, 2018-0765801C6 F - Tax on Split Income

deemed s. 104(21) capital gains retained their character as stock market gains

Jean on his decease left proceeds of an insurance policy and non-registered investments (which had been acquired by him out of accumulated savings) under a trust (“Trust”) for the exclusive benefit of his surviving spouse (“Jeanne,” also a Canadian resident), and with two of their children as trustees. Is the income generated by Trust and distributed to Jeanne subject to the tax on split income?

After assuming that Trust's investment income consists of taxable dividends on shares listed on a designated stock exchange ("Dividends"), taxable capital gains from the disposition of such shares ("Capital Gains") and interest on debt obligations ("Interest"), CRA (before going on to address the Interest) found that the distributed Dividends were not split income by virtue of the ss. (a)(i) and (c)(ii)(A) exclusions in the “split income” definition, and that

the amount representing the portion of the Distribution that relates to the Capital Gains would not be split income for Jeanne by virtue of the exception provided in clause (e)(ii)(A) of the definition of "split income" in subsection 120.4(1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Related Business - Paragraph (a) - Subparagraph (a)(ii) related business if children manage investment business of trust whose interest income is distributed to mother 431
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(c) - Subparagraph 120.4(1.1)(c)(ii) s. 120.4(1.1)(c)(ii) exclusion where investment portfolio business of spousal trust had been carried on directly by deceased husband 322

Split Portion

Paragraph (b)

Finance

2017 CTF Finance Roundtable, Q.7

If, for example, mother provides start-up capital for her son’s company, Finance accepts that it would be reasonable for her to receive a high return to reflect the high risk.

Articles

Kevyn Nightingale, "Private Company Income Splitting: Part 2 – Observations", Tax Topics (Wolters Kluwer), No. 2371, 17 August 2017, p. 1

Split income if outputs exceed inputs (p. 2)

The proposals imply that outputs are equal to inputs. …

[A]ssume that in a successful family business, each individual receives appropriate salaries for the time and effort contributed to the business. After payment of these salaries, the business still has retained earnings and marketable goodwill. Under the proposals, all dividends and capital gains — to everybody — will be split income and taxed at the top rate.

Need to trace inputs back to inception (p. 3)

It often takes years of toil before the business is successful. … To be effective, measurement of input then must go back to inception, which is not practical.

Detailed functional analysis required to justify minor tax avoidance (p. 3)

The functional analysis required to administer this proposal is, substantially, the same as that done with large international businesses in transfer-pricing audits. Forcing [entrepreneurs] to track hours worked, specific tasks undertaken, and the decisions made by each family member places an unrealistic burden on business owners.

The amount of money at stake is typically small by audit standards. It is rare to see less-active participants paid even as much as $100,000 — beyond that, the benefits of income splitting are quite small anyway. The biggest benefit is on the first $30,000 of dividends or so, where there is no personal tax payable, yielding a net tax savings of about $14,000 (assuming the income would otherwise be taxed at the top marginal rate).

Examples of difficulties in measuring contribution (p. 3)

Focusing on labour contributions over a period of years, consider dividends paid to all of the following individuals, or gains realized on sales of their shares, in the following situations: ...

  • Adult children are materially involved, but their parents, who used to run the business, are reducing their involvement or are retired. …
  • A family starts a business, which requires a great deal of time and effort from all family members for many years. Eventually the business becomes very successful and it is turned over to professional management. It runs for many years with little involvement of those same family members.

[6 other interesting examples omitted]

Difficulties in measuring arm’s length return on capital (p. 4)

Focusing on capital contributions, consider dividends in the following situations:

  • A young person starts a tech business. He is not credit-worthy, so no third party will lend him money. His family provides $10,000 in seed money in return for a small interest in the business. The business takes off and the family sells out a year later to second-level investors for $500,000.
  • A person is running a successful business, but runs into temporary difficulty, because a client goes bankrupt. The bank is unwilling to extend further credit. In order to make payroll, her family provides her with $20,000 in return for a share of the future profits. When the business recovers, she pays back double. …

The nature of the small business financed by family is that the appropriate arm's-length return is almost impossible to calculate — in many cases, no arm's-length person would finance the operation on any terms. Families do so precisely because they are not at arm's length.

Subsection 120.4(1.1)

Paragraph 120.4(1.1)(a)

Administrative Policy

6 August 2019 External T.I. 2019-0792001E5 F - Tax on split income and excluded business

paid but non-worked days do not count

If an employee normally works 7 hours per day but in a particular week she has a holiday day (e.g., a statutory holiday) for which she is paid, will her weekly hours for purposes of s. 120.4(1.1)(a) be 28 or 35 hours? In responding, “28 hours,” CRA stated:

The test in paragraph 120.4(1.1)(a) is expressly based on the average hours worked for the business in the year. Thus, to the extent that a pay period included, in addition to compensation for hours worked, remuneration for different days of holidays such as statutory holidays, sick days, or annual vacation, only hours worked should be considered for the purposes of that test.

CRA went on to note that the “actively engaged on a regular, continuous and substantial basis” potentially could be satisfied with less than 20 hours per week during the relevant period, and that:

The more an individual is involved in the management or day-to-day operations of the business, the more likely it is that individual will be viewed as engaged in the business on a regular, continuous and substantial basis.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(ii) no excluded amount where excluded business had ceased in prior year 268
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(d) - Subparagraph 120.4(1.1)(d)(ii) same-year limitation of the exclusion for income derived from the proceeds of an excluded business 222

7 June 2019 STEP Roundtable Q. 4, 2019-0799911C6 - TOSI & Meaning of Excluded Business

spouse on achieving 20-hour threshold could receive large dividends as excluded amounts

The spouse (the “Spouse”) of a professional (the “Individual”) owns non-voting preferred shares of his professional corporation (“XCo”) and works at least 20 hours per week as a part-time receptionist. A comparable part-time receptionist would receive $18,000 per annum in salary. However, Spouse receives an annual dividend of $150,000. Are such dividends excluded amounts?

CRA indicated that if Spouse works for XCo at least 20 hours per week throughout the portion of the year that the business operates, that would satisfy s. 120.4(1.1)(a), and the dividend income received by Spouse would be considered to be an excluded amount because it is derived from an excluded business – so that it would not be subject to the tax on split income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Business an excluded amount can exceed arm’s length remuneration for the services rendered 89

7 June 2019 STEP Roundtable Q. 3, 2019-0799901C6 - TOSI and Hours Worked

falling below 20 hours not presumptive

A business is carried on through a corporation owned by husband and wife, who each contribute 5 hours per week of time to the business. This did not exceed the 20 hours per week safe harbour in s. 120.4(1.1)(a). CRA noted that this was similar to Example 9 of CRA’s split-income guidelines, and stated that they both could be considered to be actively engaged in the business – but indicated that this was a question of fact.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Business husband and wife each contributing 5 hours per week to business could have an excluded business 222

26 September 2018 External T.I. 2018-0770911E5 - Revised income sprinkling rules

parental leave need not detract from satisfying the regular, “continuous” and substantial TOSI test

Would the correspondent’s spouse, who normally works, on average, more than 20 hours per week in the business of the correspondent’s corporation for the year, but who is currently on leave due to the birth or adoption of a child, still be considered to have been “actively engaged on a regular, continuous and substantial basis” in the activities of the business for that year?

After quoting a statement in the Explanatory Notes that:

An average work commitment of less than 20 hours per week could qualify as regular, continuous and substantial where, for example, an individual works 30 hours per week in a year-round business up to the start of July, after which they are unable to continue working throughout the remainder of the year (e.g., because of injury, illness or the birth or adoption of a child).

CRA stated:

Based on the above, there are certain situations where the average work commitment could be considered as being “regular, continuous and substantial” even if the bright-line deeming rule is not met. Accordingly, the fact that an individual was unable to work for a portion of a year in which the business operated due solely to the adoption or birth of a child would not, in and by itself, mean that the individual was not otherwise considered to meet the regular, continuous and substantial requirement for that year.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Business parental leave did not detract from satisfying activity level test 166

25 May 2018 External T.I. 2018-0761601E5 - Correspondence with XXXXXXXXXX re Tax on Split Income

keeping time logs will “ensure that businesses are able to comply with the new rules”

How must a business owner show that a spouse or child worked at least 20 hours in the business in the past five years if no formal records were kept? After referring to the desirability of “timesheets, schedules, or logbooks” or payroll records showing hours, CRA recognized “the challenges presented” for demonstrating the 20-hour test for pre-2018 years, and stated:

Where … information is provided in support of assertions that the 20 hour per week threshold was met in prior years, the CRA will if necessary, consider whether the assertions are reasonable having regard to such factors as

  • The type of business and duties performed as they relate to the main activities of the business
  • The individual’s education, training and experience
  • Any particular knowledge, skills or know-how that the individual possessed

Going forward, the ongoing maintenance of such records in respect of any family members involved in the business will ensure that businesses are able to comply with the new rules and obtain the benefits of available exclusions, even as family members leave the business.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (b) no excluded share exception where interposition of family trust or holdco 121
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(ii) where spouse works in only one of two businesses, excluded amount determination requires “separate accounting for each business and a tracing of funds” 158
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (a) - Subparagraph (a)(i) shares of pizzeria but not hair salon were excluded 232

Paragraph 120.4(1.1)(b)

Administrative Policy

7 June 2019 STEP Roundtable Q. 6, 2019-0799941C6 - TOSI tracing of attributes

a subsequent bequest of Opco shares from the active mother converts previous bequest of shares from the inactive father into good shares for TOSI purposes

Mr. A (who had a passive role in Opco’s business) died one year before Mrs. A (who had been actively involved for more than five years), and their surviving children (who were inactive) received a bequest of some shares of Opco directly from Mr. A, and then some from Mrs. A. Is each child entitled to the excluded business exemption in respect of all future dividends received from Opco?

CRA indicated that since Mr. A was not actively engaged in the activities of the business before his death, his shares bequested directly to the children would not satisfy s. 120.4(1.1)(b)(ii).

However, beginning in the taxation year in which the children inherit Mrs. A’s Opco shares as a consequence of her death, that deeming rule would apply, so that each child would be deemed to be actively engaged in the business of Opco throughout the five previous taxation years. Thus, any dividends received on any of their Opco shares (from the taxation year in which they inherited Mrs. A’s shares onward) would not be subject to the tax on split income, including the shares that they previously acquired as a result of Mr. A’s death.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(b) - Subparagraph 120.4(1.1)(b)(ii) successive legatees can rely on the same activity-level of the original testator under s. 120.4(1.1)(b)(ii) 227

7 November 2018 External T.I. 2018-0777361E5 - TOSI and dividend income, including from a trust

general discussion of s. 120.4(1.1)(b)

CRA found that where an estate received a deemed dividend on the redemption of preferred shares of a corporation carrying on an investment business, that dividend when distributed by it to the family beneficiaries (age 24 or older) did not qualify in their hands as “excluded amounts” (under subpara. (g)(i) of the s. 120.4(1) definition because they were not the owners of the preferred shares, as required under the definition of “excluded shares” in s. 120.4(1). CRA went on to provide the following general discussion of s. 120.4(1.1)(b):

Paragraph 120.4(1.1)(b) provides a continuity rule for inherited property and applies to amounts that would, absent the application of this rule, be split income of a specified individual who has attained the age of 17 years before the year in respect of property that was acquired by, or for the benefit of, the specified individual as a consequence of the death of another person.

In such circumstances, subparagraph (i) of this paragraph would allow a specified individual to avoid the application of the TOSI to the extent that the amount, had it been received by the deceased person, would have been a “reasonable return” for the purposes of subparagraph (g)(ii) of the “excluded amount” definition.

Subparagraph (ii) of this paragraph would allow a specified individual to avoid the application of the TOSI to the extent that the amount, had it been received by the deceased person, would have been from an “excluded business” for the purposes of subparagraph (e)(ii) of the “excluded amount” definition. This continuity rule would apply because the deceased person was, or was deemed to be because of this paragraph, actively engaged on a regular, continuous and substantial basis in the activities of the related business throughout five previous taxation years.

We have not been provided with sufficient facts to determine whether the rule described in paragraph 120.4(1.1)(b) would apply in your circumstances.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares an estate is a blocker for accessing the TOSI excluded share exemption 339

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Flow-through of attributes on 3rd generation transfers, inheritance from active and inactive parents or as a result of single property transmission respecting a business (pp. 14-15)

  • It is not entirely clear whether s. 120.4(1.1) applies for third-generation transfers, e.g., Person 2 inherits property (and attributes) from Person 1, and then Person 3 inherits property (an attributes?) from Person 2.
  • S. 120.4(1.1)(b) specifically limits the inheritance of attributes to those of the deceased. Mother and Father own 50% of Opco, which carries on an “excluded business” in respect of Mother only (Father has been inactive). Son, who inherits Opco shares from them, inherits the attributes of Mother so that Opco’s business is considered an “excluded business” of Son for the remainder of his lifetime. “Whereas, Daughter inherits the attributes of Father and will not be able to access the “excluded business” or “reasonable return” exclusions unless she becomes actively engaged in the business. The property acquirer should arguably inherit the attributes of the deceased and any current and former spouse or common-law partner of the deceased.”
  • It appears that the application of s. 120.4(1.1)(b) can be triggered by the inheritance of a single property, and the benefit of its application is applied to all properties of the inheriting individual with respect to the business in question.

Subparagraph 120.4(1.1)(b)(ii)

Administrative Policy

3 December 2019 CTF Roundtable, Q.7

shares distributed out of an inter vivos trust on an active individual’s death were received as a consequence of death for s. 120.4(1.1)(b)(ii) purposes

Mr. X owns 100,000 voting preference shares of a corporation (“Investco”), whose non-voting common shares had been acquired on an estate freeze by a discretionary inter vivos trust (the “Family Trust”), whose beneficiaries (all over 18) included him, Ms. X and their children (Ms. Y and Ms.), and whose terms complied with s. 74.4(2). Mr. X annually worked full-time in Investco’s business.

On his death in Year 1, one preference share was bequeathed to each of Ms. Y and Ms. Z, and 99,998 preference shares to Ms. X. In Year 2, a dividend received on the Investco common shares is distributed by the Family Trust to Ms. Z.

(a) Would such taxable dividend received by Ms. Z be considered to be derived directly or indirectly from an “excluded business” of Ms. Z having regard to s. 120.4(1.1)(b)(ii)?

(b) What if Mr. X instead bequeaths his preference shares to Ms. X and, as dictated under the terms of the Family Trust, on the death of Mr. X, the Investco common shares are distributed equally to Mr. X’s children – so that the Year 2 dividend is received directly by Ms. Z on the Investco common shares?

(a) CRA indicated that because the dividend is in respect of the common shares of Investco, the s. 120.4(1.1)(b)(ii) deeming rule would not apply, because those shares were owned by the family trust and were not acquired by, or for the benefit of, Ms. Z as a consequence of the death of Mr. X. Accordingly, the excluded business exception would not apply in respect of Ms. Z.

(b) Here, the dividend is received by Ms. Z on the Investco common shares acquired by her on the winding up of the inter vivos trust. CRA has considered that property received from an inter vivos trust, the terms of which unconditionally require that it distribute the property to the individual on the death of another person, can be considered as property acquired as a consequence of that person’s death. Accordingly, Ms. Z’s Investco common shares will be considered as property that was acquired her as a consequence of the death of another person, so that s. 120.4(1.1)(b)(ii) will deem Ms. Z to have been actively engaged in Investco’s business based on Mr. X’s previous involvement in the business. As a result, Investco’s business will be an excluded business of Ms. Z.

Regarding GAAR, CRA would look for a sufficient connection between the deceased person and the property that is being distributed and the specified individual to support the application of the deeming rule in these circumstances.

7 June 2019 STEP Roundtable Q. 6, 2019-0799941C6 - TOSI tracing of attributes

successive legatees can rely on the same activity-level of the original testator under s. 120.4(1.1)(b)(ii)

Mrs. A has been actively engaged in the (services) business of Opco for at least five years, whereas Mr. A, the other shareholder, had not been so engaged. Opco shares, which were bequeathed to Mr. A under Mrs. A’s will passed, in turn, on his death to his children. Can the children rely on s. 120.4(1.1)(b)(ii)?

CRA indicated that Mr. A. would be deemed to have been actively engaged in the activities of Opco’s business throughout the five previous taxation years for purposes of the excluded business definition, for all years starting with the year in which the Opco shares were inherited. Furthermore, the effect of a previous application of s. 120.4(1.1)(b)(ii) could extend to a subsequent acquisition of property as a consequence of the death of another individual. Thus, when the children inherited Mr. A’s Opco shares as a consequence of his subsequent death, s. 120.4(1.1)(b)(ii) would deem each child to be actively engaged in the activities of the business for five prior taxation years, because Mr. A. was also deemed by that same provision to have satisfied that requirement. Therefore, any dividends arising on any of the shares of Opco owned by the children, for any taxation year starting with the year in which they inherited the Opco shares, would not be subject to the tax on split income.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(b) a subsequent bequest of Opco shares from the active mother converts previous bequest of shares from the inactive father into good shares for TOSI purposes 199

Paragraph 120.4(1.1)(c)

Administrative Policy

Guidance on the application of the split income rules for adults 15 December 2017 CRA Webpage

Example 12 (spouse over 65)

Spouse A and B, aged 65 and 60, own 95% and 5% of the shares of Investco, whose active business was actively managed by Spouse A (with no involvement of Spouse B) before it became a portfolio company. The payment by Investco of substantially all of its net investment income to them to augment their retirement income will give rise to excluded amounts to Spouse B given “because, on the one hand, it would be an Excluded Amount in respect of Spouse A if it had been included in the income of Spouse A and, on the other hand, Spouse A is over age 65.”

Subparagraph 120.4(1.1)(c)(ii)

Administrative Policy

7 June 2019 STEP Roundtable Q. 5, 2019-0799961C6 - TOSI and Spouse Age 65+

example of the flow-through of the s. 120.4(1.1)(c) excluded amount exclusion through a trust

Will the s. 120.4(1.1)(c) exclusion apply where the deceased spouse qualified under the “excluded shares” exception based on direct ownership of the shares, and the surviving spouse holds the shares through a holding company or trust?

CRA referred to the example of individual A, the deceased spouse of a specified individual, owning excluded shares of Canco throughout A’s last taxation year before A’s death. The specified individual is a beneficiary of a Canadian-resident trust, which acquired Canco shares during A’s lifetime. Canco carries on a related business with respect to A and the specified individual.

Canco pays a dividend to the trust, which is then distributed by it to the specified individual. The exclusion in s. 120.4(1.1)(c)(ii) will apply if the dividend would have been an excluded amount of A had it been included in computing A’s income for A’s last taxation year before death.

CRA considered that the ownership requirement in para. (b) of “excluded shares,” for this purpose, is based on the actual ownership of the shares by the deceased spouse in the relevant year.

Given that A owned shares of Canco throughout A’s last taxation year before death, those shares satisfied the requirements for being excluded shares during that period, and CRA considers that the amount of the dividend that was notionally included in A’s income to have been income from those shares, so that such dividend would have been an excluded amount in respect of A had it been included in A’s income in A’s last taxation year, because it would have been income from excluded shares.

The dividend in that case should be deemed to be an excluded amount in respect of the specified individual under s. 120.4(1.1)(c)(ii), and a similar analysis would also apply in respect of the situation in s. 120.4(1.1)(c)(i), which is where the spouse or common-law partner was 65 years or older in the year.

5 October 2018 APFF Financial Strategies and Instruments Roundtable Q. 4, 2018-0765811C6 F - Tax on Split Income

exclusion where rental portfolio of spousal trust was a directly-conducted business of deceased husband

A spousal trust for Jocelyne (“Trust”) holds five commercial rental properties (generating $250,000 in annual rents, which had been managed by her deceased husband). Is the income generated by Trust and distributed to Jeanne subject to the tax on split income where the Trust investments are managed by Jocelyne’s son Julien?

CRA noted that the net rental income distributed to Jocelyne might come within s. (c)(ii)(D) of the definition of "split income" depending on the level of involvement of Julien, but went on to indicate that even if this were the case, the exclusion in s. 120.4(1.1)(c)(ii) would appear to apply:

By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jocelyne's income from property is deemed to be an excluded amount to the extent that the amount would have been an excluded amount in respect of an individual - Joseph – who was, immediately before his death, Jocelyne's spouse or common-law partner, if the amount were included in computing Joseph's income for his last taxation year.

The Distribution would have been an excluded amount in respect of Joseph since it was not derived directly or indirectly from a related business in respect of Joseph by virtue of subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).

Since Joseph owned the commercial rental properties directly, and even under the assumption that Joseph derived income from a business, that business could not be classified as a related business.

Indeed, by virtue of subparagraph (a)(i) of the definition of "related business" in subsection 120.4(1), the business carried on by an individual must be carried on by a source individual in respect of the specified individual. Since Joseph could not be a source individual in respect of himself, the hypothetical business could not be a related business in respect of Joseph.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Split Income - Paragraph (c) - Subparagraph (c)(ii) - Clause (c)(ii)(D) no TOSI on net rental income of spousal trust on properties managed by son if excluded amounts 181

5 October 2018 APFF Financial Strategies and Financial Instruments Roundtable Q. 3, 2018-0765801C6 F - Tax on Split Income

s. 120.4(1.1)(c)(ii) exclusion where investment portfolio business of spousal trust had been carried on directly by deceased husband

Jean on his decease left proceeds of an insurance policy and non-registered investments (which had been acquired by him out of accumulated savings) under a trust (“Trust”) for the exclusive benefit of his surviving spouse (“Jeanne,” also a Canadian resident), and with two of their children as trustees. Are the dividends and taxable capital gains generated by Trust from its investments in shares listed on a designated stock exchange, and interest on debt obligations, subject to the tax on split income (TOSI) when distributed to Jeanne qua beneficiary?

CRA first found:

  • the distributed dividends and capital gains were not split income by virtue of the ss. (a)(i), (c)(ii)(A) and (e)(ii)(A) exclusions in the “split income” definition,
  • the distributed interest would not constitute income from a “related business” (as per s. (a)(ii) of the definition) if Trust did not carry on business.
  • subject to the point below, if the Trust instead carried on a business, then that business would be a related business respecting Jeanne (thereby subjecting the distributed interest to TOSI) if that business was managed by a child qua trustee or as stock broker retained by the trust and the “actively engaged on a regular basis” test was satisfied.

However, CRA then stated:

By virtue of subparagraph 120.4(1.1)(c)(ii), the amount that is Jeanne's income from property is deemed to be an excluded amount to the extent that the amount would have been an excluded amount in respect of an individual - Jean – who was, immediately before his death, Jeanne's spouse or common-law partner, if the amount were included in computing Jean's income for his last taxation year.

The portion of the Distribution with respect to the Interest would be an excluded amount in respect of Jean since it was not derived directly or indirectly from a related business in respect of Jean under subparagraph (e)(i) of the definition of "excluded amount" in subsection 120.4(1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Split Income - Paragraph (e) - Subparagraph (e)(ii) deemed s. 104(21) capital gains retained their character as stock market gains 177
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Related Business - Paragraph (a) - Subparagraph (a)(ii) related business if children manage investment business of trust whose interest income is distributed to mother 431

Paragraph 120.4(1.1)(d)

Administrative Policy

12 June 2019 External T.I. 2019-0792011E5 F - TOSI definition excluded shares

income derived from related business included income from reinvesting sales proceeds from sale thereof in preceding year

In Year X3, Investco sells all the shares of Opco, which was the only related business respecting the specified individual (Investco’s shareholder) and uses the proceeds in an investments business. CRA indicated that dividends paid by Investco to the individual shareholder cannot qualify for the excluded share (“tax on split income” or TOSI) exception until Year X5. For instance, in Year X4, the income of Investco was tainted because in its last taxation year (X3) it had received dividend income from Opco and, in any event, the taxable capital gain realized by it in that year was deemed by s. 120.4(1.1)(d)(i)(B) to be income derived from the Opco business.

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Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Shares - Paragraph (c) two years were required to pass before proceeds from the sale of a related business could generate excluded share income for TOSI purposes 268

2 November 2018 External T.I. 2018-0771861E5 - TOSI: Second generation income

amounts derived from a related business do not include capital gains from the passive investment of the dividends therefrom

Mr. and Mrs. A (both over 30) respectively own 100 voting and 100 non-voting common shares of Investco which wholly-owns Opco (with a non-services business). Only Mr. A is actively engaged in Opco’s business on a regular, substantial and continuous basis.

In Year 1, Opco pays a $1M dividend to Investco which Investco invests in shares of publicly-traded corporations; then in Year 2, Investco pays a dividend-in-kind to Mrs. A of its entire portfolio which, at that time, has an aggregate FMV of $1.1M (for an accrued gain of $0.1M). Would this dividend be characterized as income that is derived directly or indirectly from a related business for s. 120.4 purposes – and would the answer change if the dividend was paid before 2018?

After quoting s. 120.4(1.1)(d), and before concluding that only $1.0M of the $1.1M dividend-in-kind received by Mrs. A would be derived from the related business of Opco in respect of Mrs. A (so that if Investco does not have a related business in respect of Mrs. A, $100,000 of the amount would not be derived from such a business), CRA stated:

The portion of the FMV of the distributed stock portfolio that represents the initial investment of the dividends paid by Opco to Investco would be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A. However, gains earned by Investco as a result of the investment of those dividends would not be considered to be derived, directly or indirectly, from the related business of Opco in respect of Mrs. A.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(i) dividends generated from the investment of dividends received from a related business (or gains from such investments) are not themselves derived from that business 375

Subparagraph 120.4(1.1)(d)(ii)

Administrative Policy

6 August 2019 External T.I. 2019-0792001E5 F - Tax on split income and excluded business

same-year limitation of the exclusion for income derived from the proceeds of an excluded business

CRA acknowledged that the “derived directly or indirectly” phrase in s. (e)(ii) of the definition of “excluded amount” was quite broad, and also adverted to the rule in s. 120.4(1.1)(d)(ii) that includes within that phrase an amount derived (in turn) from an amount that arose from the disposition of an excluded business. CRA concluded that where Mr. X’s company, which had a (construction) excluded business and used the proceeds of sale of that business to establish an investments business in which Mr. X had no involvement, the dividends now paid to Mr. X out of the income of that business were not excluded amounts. CRA stated:

[T]o the extent that it could be determined that the amount in question was derived from the investment business carried on by ABC Inc., that amount could not constitute an "excluded amount" by virtue of subparagraph (e)(ii) of the definition … .

[I]t would not be possible to consider that an amount distributed by a corporation in a year subsequent to the disposal of the activities of the business is derived from that business for the year. … [S]ince the construction business was not carried on in the year in which the dividend was received by Mr. X, it could not qualify as an excluded business of Mr. X for the year.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1) - Excluded Amount - Paragraph (e) - Subparagraph (e)(ii) no excluded amount where excluded business had ceased in prior year 268
Tax Topics - Income Tax Act - Section 120.4 - Subsection 120.4(1.1) - Paragraph 120.4(1.1)(a) paid but non-worked days do not count 176

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Broad scope including potential iterative derivation (pp. 11-12)

Would the following amounts be considered as derived directly or indirectly from a “related business” carried on by Opco in respect of a specified individual:

  • A dividend from the Opco business is invested by the corporate recipient (Parentco) to earn investment income, with Parentco then paying a dividend therefrom to the specified individual.
  • The Opco dividend is received by the specified individual, who invests it in shares of Opco 2, which does not carry on any “related business” respecting the individual, with the shares subsequently generating income or a capital gain. (“[I]t seems particularly inappropriate for the rule to apply in situations such as [this], where amounts could be deemed to be derived from a related business “through” amounts that have already been received by, and taxed in the hands of an individual.”)
  • The “related business” of Opco in respect of the specified individual ceased 10 years ago, with Opco now paying out dividends from the passive investment income generated from the invested retained earnings.
  • Opco lends to Investco, which invests the funds in passive investments and pays out dividends to the specified individual out of the investment income to the specified individual.
  • Opco lends to Newco, which invests the funds in a business conducted by the specified individual, and pays out dividends to the specified individual from the income generated therefrom. “Is some sort of tracing required as to whether and what portion of Newco’s income is attributable to the capital from Opco, labour and other contributions of the specified individual, and/or other factors enabling Newco’s business to thrive?”

Subsection 120.4(3)

Articles

Joint Committee, "Legislative Proposals to Address Income Sprinkling Released December 13, 2017", 8 March 2018 Joint Committee Submission

Failure of attribution rules to generate FTCs (p. 15)

Attributed income will not be entitled to foreign tax credits under subsection 120.4(3) because foreign tax is not deemed to be paid by the individual to whom income or capital gain is attributed. This is a broader issue than TOSI as this mismatch arises also with Part I income tax whenever income is attributed.

Govindadeva Bernier, Tim Scholz, "Income Sprinkling Using Private Corporations", Office of the Parliamentary Budget Officer (with thanks to “Finance Canada officials for their helpful technical discussions”), 8 March 2018

95% of additional federal tax to be collected from families with taxable income over $150,000

The Parliamentary Budget Officer (PBO) … computed possible revenue outcomes for the government based on three different scenarios.

In all three scenarios, we considered dividends paid to adult family members as not being subject to the TOSI, for individuals where:

  • the employment income based on the T4 slip issued by a family owned- CCPC was above a $15,000 threshold;
  • if they were 25 years of age or older, they owned at least 10 per cent of the shares of a family- owned CCPC that was not in the service or professional sector;
  • they were the spouse of a primary owner aged 65 or over.

Scenario 1

In this scenario, we also excluded all the spouses aged 25 or over from being subject to the new TOSI rules. The rationale behind this scenario is that it is likely that most spouses have assumed some risk in the family business (for example, using the house as collateral for a bank loan to start the business). Therefore, we assume they would pass the reasonableness test and see the dividends they received as being exempt from the TOSI. This is our preferred scenario. …

Under scenario 1, PBO’s preferred scenario, the new policy changes would result in an estimated $589-million increase in taxation revenues [for 2018-19], $356 million or 60 per cent of which would go to the federal government. Families in Ontario would pay $224 million more in federal taxes, close to 63 per cent of the total [compared to $46M/13% for Alberta and $23M/6.5% for Quebec]. More than 95 per cent of additional federal tax payable would come from families with family taxable income above $150,000.

Subsection 120.4(4) - Taxable capital gain

Administrative Policy

10 June 2013 STEP Roundtable, 2013-0480261C6 - 2013 STEP Roundtable Question 1

crystallizations; elected dividends
Crystallization transaction

A child of parent seeks to crystallize an accrued gain on shares of Opco, which is controlled by parent, by transferring those shares to Opco in exchange for Opco issuing shares. As the child disposed of the shares to a non-arm's-length person, s. 120.4(4) would apply to deem the child to have received a taxable dividend equal to twice the amount of the taxable capital gain.

s. 48.1(1) does not apply

As expressly provided in s 48.1(1), a capital gain realized by a specified individual as a result of a deemed disposition under s. 48.1(1) is not subject to the tax under s. 120.4.

No s. 83(2) election

As ss. 120.4(4) and (5) only deem twice the amount of taxable capital gains to be received as a taxable dividends, and do not deem any amount to be paid by the corporation, a dividend refund is not available under s. 129(1) nor is a capital dividend election under s. 83(2).

22 October 2012 External T.I. 2012-0432241E5 F - Impôt des enfants mineurs - gain en capital

purported dirty s. 85(1) capital gains crystallization by minor child instead generates dividend

A minor child holding shares of a corporation equally with the child’s parent and who wishes to "crystallize" the capital gains deduction provided in s. 110.6(2.1) effects an exchange under s. 85(1) of the child’s shares for preferred shares. Does s. 120.4(4) apply? CRA responded:

[T]he corporation and the specified individual are not dealing at arm's length by virtue of paragraphs 251(1)(a) and 251(1)(b). In this context, all of the elements triggering the application of subsection 120.4(4) are present and the specified individual will be deemed to have received a taxable dividend other than an eligible dividend.

Since by virtue of subsection 120.4(4) the minor child is deemed not to have a capital gain, such a transaction would not allow the child to "crystallize" the capital gains deduction under subsection 110.6(2.1).