As I noted in my last blog, the Minister of Finance released revised draft legislation and explanatory notes for proposed changes to the tax on split income (“TOSI”) on December 13, 2017. The new rules are an improvement on the original July 18, 2017 release, in that they have been simplified in some respects. Nevertheless, they remain complex and questions remain about their application. The devil, as they say, is in the details, and that is particularly true with amendments to the Income Tax Act (Canada). Given the complexity of the rules, the aim of this blog is modest; namely, to provide a high-level overview of key aspects of the rules.
In general terms, dividends and interest paid to an individual (the “recipient”) from a private corporation that is a related business (in relation to the recipient), and certain capital gains on the disposition of shares of a related business, will be subject to the TOSI and taxed at the highest marginal rate. A related business is a business in which an individual who is related to the recipient is actively engaged or has a sufficient ownership interest. Certain amounts are excluded from the general rule and not subject to the TOSI:
- income or gains if the individual is age 18 or older and is actively engaged on a regular, continuous and substantial basis in the business in the year or any five prior years, which need not be consecutive (in which case the related business is an “excluded business”);
- if an individual is age 25 or older, income or gains on shares owned by the individual (and not a trust) if the individual holds 10% or more of the votes and value of the corporation, it is not a professional corporation, it earns less than 90% of its income from services, and substantially all of the income of the corporation is not derived from another related business (defined as “excluded shares” in the legislation);
- if an individual is age 25 or older, income or gains that are not from an excluded business or excluded shares but represent a “reasonable return”, taking into account the individual’s labour contribution, capital contribution, risk assumed, historical payments to the individual, and any other relevant factors;
- if an individual is between age 18 and 24 and receives an amount that is not from an excluded business:
- a prescribed rate of return on the individual’s capital contribution to the business, based on a formula; or
- a reasonable return, if the capital contributed to the business qualifies as “arm’s length capital” under the legislation;
- amounts received by a business owner’s spouse if the business owner is age 65 or older and meaningfully contributed to the business;
- for all individuals, gains realized on death or on the disposition of qualified farm or fishing property or qualified small business corporation shares, except where the gain is realized by a minor on a non-arm’s length disposition; and
- income or gains on property that a spouse receives as part of a settlement on relationship breakdown.
Under the new rules, an individual is deemed to be actively engaged in a business in a year if the individual works an average of 20 hours per week during the period of the year the business operates. In addition, special rules apply in respect of income and gains on inherited property, which are intended to put the beneficiary of the property in the same tax position as the deceased.
If the new rules are passed in their current form, they will apply from January 1, 2018, although individuals will have until the end of 2018 to meet the ownership test in item 2 above (the “excluded shares” exclusion).
It will take some time for advisors to work through all of the implications of the new rules for existing and proposed plans involving private corporations. What we do know is that the same income distribution from a private corporation may attract rather different tax consequences in 2018 than it did in 2017.