All About Estates

Estate planning and TOSI – Part I

Finance stated that the purpose of the revised tax on split income (TOSI) regime, which became effective January 1, 2018 was “to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling their income to family members who do not really contribute to the business.”[1]

The objectives related to estate planning generally have nothing to do with income splitting, but families with private companies need to consider TOSI given that all shareholders of privately held companies are subject to the rules unless a legislative excluded amount under section 120.4 of the Income Tax Act (ITA) is available.

Fortunately, the TOSI rules contemplate and try to accommodate estate planning by providing continuity rules to afford a beneficiary, who may not qualify on their own merits, with an excluded amount. There are three different continuity rules, which are as follows:

  1. 120.4(1)(a) “excluded amount” – a specified individual who has not attained the age of 24 years before the year and inherits the property,
  2. 120.4(1.1)(c)(ii) – a specified individual who is a spouse that inherits the property, and
  3. 120.4(1.1)(b) – a specified individual who has attained the age of 17 years before the year that inherits the property.

Each of these continuity rules operate slightly differently, but they all have the same basic premise, which is to afford the beneficiary with an excluded amount exception to the TOSI rules. The first two continuity rules provide for an excluded amount, as long as the conditions in that paragraph or subparagraph are met, whereas the third rule only allows the beneficiary to step into the shoes of the deceased with regards to the following excluded amounts:

  • Reasonable return,
  • Excluded business in relation to paragraph (b) of the definition of excluded business in subsection 120.4(1) of the ITA – (actively engaged on a regular, continuous, and substantial basis in the activities of the business for any five prior taxation years), or
  • If applying paragraph (g) of the definition excluded amount in subsection 120.4 of the ITA, allowing the beneficiary to be deemed to have attained the age of 24 years before the year.

It is very important to understand the continuity rules to ensure the beneficiary is afforded an excluded amount avoiding the application of TOSI on dividends from inherited shares of a private company.

TOSI and the continuity rules

The below chart provides a summary of the three continuity rules.

120.4(1)(a)

Who it benefits


Results


Criteria


Limitations


Specified individual who has not attained the age of 24 years before the year and is: (1) the child of the deceased or (2) enrolled as a full-time student at a post-secondary educational institution or qualifies for the disability tax credit (DTC). Income or gains from property is an excluded amount Property must be acquired by, or for the benefit of, the individual as a consequence of the death of a person Only applies to income or gains from property of the specified individual until the taxation year he/she attains the age of 25. Also stops applying if the deceased was other than a parent and the specified individual no longer attends post-secondary school or qualifies for the DTC.

120.4(1.1)(c)(ii)

Who it benefits


Results


Criteria


Limitations


Surviving spouse or common-law partner Income or gains from property deemed excluded amount Hypothetical income inclusion in last taxation year of deceased must be considered an excluded amount Deceased person must be a spouse or common-law partner immediately before death

120.4(1.1)(b)

Who it benefits


Results


Criteria


Limitations


Specified individual who has attained the age of 17 years before the year Deemed to inherit the deceased’s excluded amount attributes for:

– Reasonable return,

– Excluded business (5 year actively engaged test),

– Age requirement for paragraph 120.4(1)(g)

Property must be acquired by, or for the benefit of, the individual as a consequence of the death of a person

 

 

Look through to deceased individual’s attributes. Therefore, specified individual only applies if the deceased individual would have qualified.

As you can see from the above table, each continuity rule has specific criteria which was designed to deal with specific beneficiaries. As long as the criteria is met in the respective continuity rule, then the beneficiary would be afforded an excluded amount necessary to avoid the application of TOSI.

Of course the devil is in the details, and when dealing with TOSI, the details are what matter. A well documented estate plan involving shares of a private company should always contemplate the application of TOSI to those individuals inheriting the company shares. But what happens when the family dynamics or the corporate structure changes over time? Specific changes in the circumstances could render access to the continuity rules in a well documented estate plan obsolete resulting in the unintended application of TOSI.

Stay tuned for Part II of this blog series where I will review some situations that can occur which can result in the loss of the continuity rule subjecting the beneficiary to TOSI.

[1] Department of Finance News Release, December 13, 2017

About John Oakey
National Tax Director for Baker Tilly Canada. John has extensive experience with Canadian corporate and personal income taxes with specialization in the areas of corporate reorganizations, estate planning, succession planning and tax compliance. He also has significant experience dealing with GST/HST issues and U.S. citizen cross-border tax reporting issues.

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