Since July 2017, there have been many discussions among small business owners about how changes to tax on family income earned in a private corporation will be affected. The 2017 proposals related to Tax on Split Income represented the biggest change to private company taxation since 1972 and after more than 29,000 submissions the rules were finalized effective January 1, 2018. Yet, even into the 2019 tax season, I continue to field queries on the subject.
The original TOSI rules were introduced in 1999 and were limited to individuals under 18 years of age. The new rules have been extended to all individuals regardless of age and these individuals are referred in the new rules as “specified individuals”. A specified individual is a resident of Canada and related to another individual resident in Canada at any time in the year. The related person is referred to as the “source person” (the source being the source of a payment) and related to the specified individual.
Split Income includes taxable dividends and shareholder benefits from a private corporation, income received from a trust or partnership that was derived from a business, profession or rental activity of a related person, if the specified individual is under 18, a non-arm’s length gain realized on private corporation shares, income on certain debt obligations and gains from the disposition of property if the related income would have been TOSI. All these amounts will be considered split income of the person paying the income (or specified person) unless they are “excluded amounts”.
“Family owned corporations should review their authorized and issued share capital.”
An “excluded amount” is a payment whereby the relevant income is not subject to TOSI rules. There are general and specific exceptions. These rules are very detailed and complex however, they are meant to define payments made to individuals that are realistically involved on a regular and continuous basis and\or have made financial contributions to a family business. It is very important, on a go forward basis for family businesses to keep proper and detailed records to support the time and financial contributions of all related shareholders in case of a Canada Revenue Agency review or audit.
The new rules outline a “related business” concept. The new “related business” definition serves a number of functions in assessing the TOSI rules and can generally be described as the business where the split income is derived. The TOSI rules will only apply to payments where the income is derived directly or indirectly from a “related business”. In order for a business to be a related business in respect of the person receiving the income, the source person must be sufficiently connected to the business.
TOSI does not include salary paid by a private corporation to an individual as a reasonable salary is covered in a separate section of the income tax act. An unreasonable salary may be denied or reduced as an expense of a corporation.
Family owned corporations should review their authorized and issued share capital. This is important to ensure that dividends are not declared on a class of shares where for example, a husband and wife both own the same class of shares and one spouse is permitted to receive a dividend under the new rules and the other spouse is not. If the dividend that is not allowed is considered income under TOSI, this income will be attributed to the source person and the total dividend will be included in permitted spouse’s tax return.
It is very important to consult your tax professional to review the new rules, especially where family members are involved in your business.