On December 13, 2017, Canada’s Finance Minister announced the revised tax measures that relate to income sprinkling by business owners and their families. Income sprinkling refers to a strategy often used by high income businesses or incorporated professionals to redirect their income to lower earning family members to decrease their tax burden. The tax laws are multifaceted and contain some subjective provisions, but the following will outline the key points to the new laws and how they could affect your business.
In the past the “Tax on Split Income” (TOSI) rules only applied to children, often referred to as kiddie tax. The rule stated that any income split to certain family members under the age of 17 would be taxed at the highest marginal tax rates. The revised tax measures now extend the TOSI rules to other related individuals. After a public outcry when the rules were first introduced in 2017, the government has introduced the following “Bright Line” tests that exclude related individuals who meet certain qualifications:
1.Spouses of business owners, where the business owner meaningfully contributed to the business and is over the age of 64.
2. An individual who is over the age of 17 and has made regular and substantial labor contribution the corporation during the given year or during the past 5 years. The CRA will define substantial labor as an average of 20 hours a week during the year.
3. An individual over the age of 24 who owns 10% or more of a CCPC that earns less than 90% of its income from providing services, is not a professional corporation, and its income is not derived from a related business of a specified individual. If an individual meets these qualifications, the shares will be referred to as excluded shares and will not be subject to TOSI.
If a related individual does not meet the above-mentioned qualifications and is still receiving income, they will be subject to a “reasonable test.” These tests will determine how much income would be subject to TOSI. The word reasonable is defined in terms of the contributions of the related individual to the business. These contributions could include labor and capital contributions, risks assumed by the relative, and any other relevant factors. The burden on proving that a family member has made a “reasonable” contribution to a business will fall on a tax payer. The CRA suggests keeping schedules, time sheets, or log books to track family contributions to the business.
It would be prudent for all business owners to meet with their tax advisors in light of the new tax laws. Business owners should be aware of their corporations share structures, be cognizant of the fact that dividend income paid to related individuals may now be subject to the TOSI, and be diligent in documenting the contributions of related individuals to support any assessments by the CRA.