Tax on Income Splitting (TOSI) in Canada – 2020

No one wants to pay more taxes than they have to, that is why many Canadian taxpayers might choose to alleviate some of the tax burdens through a practice called “Income Splitting”.

Canada Revenue Agency’s (CRA) definition of Income Splitting

Income sprinkling – sometimes referred to as “income splitting” – is a strategy that can be used by high-income owners of private corporations to divert their income to family members with lower personal tax rates.

In simple words, income splitting is the transferring of income from a high-income family member to a lower-income family member to minimize the overall tax paid by the family. Since the Canadian tax system has graduated tax brackets, by having the income taxed in the lower-income earner’s hands, the overall household’s tax liability can be reduced.

Income Splitting Eligibility

At the federal level, you can continue to split income with your spouse or common-law partner, regardless of your age, as long as the retirement income is eligible. To qualify to split income, you and your spouse or common-law partner must reside in Canada and live together. The couple must live together for at least one year and not have been separated for more than 90 days at the end of the tax year. However, you can live apart if the reason is related to work, school, or medical necessity.

Income Splitting Rules

Income splitting is an electable action that you opt-in every year you file your taxes. 

Income tax rules state that the TOSI applies the highest marginal tax rate (currently 33%) to split the income of an individual. Previously TOSI was applied only on the individuals under the age of 18, but now, the split income of individuals over 18 will be subject to TOSI. Revised tax split income rules are expanded to include adult children and spouses. The objective is to limit or eliminate the tax benefits of income splitting where the recipient of the income has not made a sufficient contribution to the family business. The federal government’s recent changes to the taxation of private corporations have reduced the available options to cut down the tax burden. However, there are still options available to mitigate the tax liability. 

Income qualifying for TOSI

The TOSI rules will potentially apply if business owners or their family members earn the income types mentioned below:

• Dividends and shareholder benefits from the private company.
• Income received from a partnership or trust where the income was derived from a related business or the rental property in certain cases.
• Income on certain debt obligations for example interest.
• Income or gains from the disposition of private shares or other property with historical TOSI.

Exclusions from TOSI

Although income splitting is greatly restricted as a result of the expanded TOSI rules, some exceptions still allow individuals to benefit from income splitting with immediate family members (parents, child, or sibling, not an aunt, uncle, nephew, or nieces).

Excluded Business Gains

The first exception relates to the contribution of the family member to the business. If the family member receiving the income is over 18 years of age and is engaged in the business on a regular, continuous, and substantial basis, the TOSI rule may not apply.

Being engaged on a “regular, continuous, and substantial basis” is demonstrated when the respective family member hits the threshold of having worked in the business for an average of at least 20 hours per week in the current tax year, or in five previous tax years. The five years need not be in succession. Satisfying these requirements, any dividends received by a family member will not be subject to TOSI.

Providing evidence of sufficient engagement in the business may be challenging. However, obtaining all the possible information will help demonstrate the sufficient involvement of a family member in the business. 

Excluded Shares

To claim an exclusion from TOSI for the shares held by a family member, the individual must be at least 25 years of age and hold shares that represent at least 10% of the corporation (in votes and value), and 90% of the corporation’s income must be earned from a provision of services. This exclusion is applicable if the shares held by the individual must not be shares of a professional corporation for example law or accounting firms, or dentistry and physician clinics.  

Reasonable Returns

If a family member is 25 years of age or older, it is possible to pay him/her a reasonable amount of income in the form of dividends representing a reasonable return on their contribution to the business, which would be excluded from TOSI. However, CRA does not guide what it deems reasonable. The reasonable test considers contributions to the business through a combination of the work performed by the individual in the business, the property contributed by the individual to the business and, the risks that the individual has taken concerning the business.

All these measures are subjective to how CRA will assess them as no clear definition of reasonable return is provided. 

Age Exclusion

If the professional owner is over the age of 65 years and split income with a spouse or common-law partner regardless of the age of the spouse or common-law partner, the TOSI rules will not apply. This exemption is available only to the spouse or common-law partner, no other family member qualifies for it.

Conclusion

When your marginal tax rate differs significantly from those of your family members, it’s worth considering some income splitting strategies. Despite the expanded TOSI rules, there are strategies available to Canadians to work out a tax cut. Often, the difficulty lies in knowing which strategies would work best for you, here Filing Taxes plays a role to advise and help you.

The TOSI rules are extraordinarily complex, and many nuances are not discussed in this article. It is advisable to seek guidance from a tax expert about your specific business situation to determine how the TOSI rules will impact your business. If you have any questions, feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.

Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.