Who’s exempt from TOSI rules?
On Dec. 13, 2017, the government released the draft legislation for the controversial Tax on Split Income (TOSI), noting that it was simplifying earlier proposed tax measures, which would apply as of Jan. 1, 2018. These amended rules were meant to clarify the process for determining when and how a family member would be considered to have made a contribution to the business so as to be exempt from the TOSI rules. As usual, it’s complicated, so here’s a summary and recap.
The new rules set out certain exclusions to the TOSI rules for certain “specified individuals” as follows:
- A business owner’s spouse, where the owner meaningfully contributed to the business, and is aged 65 years or older (this is meant to track to the current pension income sprinkling rules in place).
- Adults aged 18 or over who are engaged on a regular, continuous, and substantial basis in the business (i.e., averaging at least 20 hours per week) during the year, or during any given previous years. If the business is seasonal, then the 20 hours per week would be applied to the part of the year the business is operational.
- Adults aged 25 or over who own 10% or more of the votes and value of the corporation that earns less than 90% of its income from providing services. This specifically excludes professional corporations, such as lawyers, accountants, doctors or dentists.
- Individuals who realize taxable capital gains from the disposition of qualified small business corporation shares or qualified farm or fishing property, provided that they would not be subject to the top tax rate on such gains under existing rules. (This is some good news, as the capital gains exemption will still be available under the current rules).
If a family member does not meet any of the above exclusions, then we would look to the new “reasonableness” tests in order to determine if a family member is considered to have meaning fully contributed to the business.
For individuals aged 25 and over, the reasonableness tests consider whether such individuals have made contributions to the business through any combination of the following factors:
- Labour contributions: Factors to look at include the nature of the tasks performed, hours required to complete the tasks, education, training and experience, business acumen and particular knowledge, to name a few.
- Property contributed directly or indirectly to, or in support of, the business. This can include amount of capital, loans, fair market value of property (including technical knowledge, skill, etc.), collateral for loans, etc.
- Risk assumed in respect of the business : Has the individual exposed themselves to the financial liabilities of the business (i.e., guarantees). Is their reputation or goodwill at risk. Is the risk indemnified?
- Total amounts paid: Are other amounts paid, such as salary, dividends, etc., access to benefits or deemed payments;
- Any other relevant factors: Individuals between the ages of 18 and 24 will be permitted a prescribed rate of return (i.e., safe harbor capital return) on capital contributed to a related business. If capital is contributed to an unrelated business, the individual will be allowed a reasonable return on the contribution.
There were some notable omissions in this version of the legislation, when compared to the original July 18 proposals. Specifically, the TOSI rules will no longer apply to the following:
- Compound income (i.e., income earned from the investment of an initial amount of income that is subject to the TOSI or attribution rules).
- Aunts, uncles, nieces, or nephews.
- Income derived from property acquired as a result of the breakdown of a marriage or common-law partnership.
Moreover, capital gains realized on a transfer of shares by adults aged 18 or over to a non-arm’s length person will not be deemed a dividend and taxed as such. However, the current rules, pre-July 18, 2017, will continue to apply for minors, subject to a proposal to provide for an exemption for minors, where a capital gain arises as a consequence of death.
The Department of Finance also confirmed that it will not move forward with the measures to limit access to the lifetime capital gains exemption. Additionally, capital gains from property that qualifies for the capital gains exemption will be exempt from the income sprinkling rules.
So where does all of this leave us? Well, we have a new version of draft legislation that is theoretically in effect as of January 1, 2018. Some of us managed to get some last-minute tax planning last December, and all of us now are subject to rules that are still in draft form. But the CRA has always taken the position that you should tax plan and file as if draft legislation is the law. So unless we hear otherwise from the government, it seems like TOSI is here to stay.
Previously published in The Fund Library on April 17, 2018 by tax and estate planning lawyer, Samantha Prasad.