Guidance on income splitting as the Senate weighs in
TAX ALERT |
As promised in October of this year, the Department of Finance released the details yesterday on how it intends to implement the income sprinkling proposals effective Jan. 1, 2018. Their announcement came on the heels of a Senate Finance committee report recommending the government either withdraw the private company tax proposals altogether in favor of a comprehensive review of the Canadian income tax system or, at a minimum, defer their implementation until Jan. 1, 2019.
Earlier this year, the Department of Finance released a comprehensive set of tax proposals aimed at perceived abuses of the tax system by private companies in order to reduce the tax burden on wealthy individuals. The proposed tax changes would, if implemented, curtail income sprinkling, eliminate the ability to receive dividend income at capital gains tax rates and increase the overall rate of tax on passive income earned in a private corporation. After a very short consultation period, the Department of Finance announced that it would provide further guidance to ease the implementation of the income sprinkling proposals.
The December 13, 2017 amendments provide guidance in determining whether a family member’s involvement in a business is enough to exclude them from the tax on split income (TOSI), that is, tax at the top marginal rate on non-salary income and gains on the sale of shares. The TOSI will not apply in the following situations:
- A business owner who is 65 years of age or older who splits income with a spouse
- The splitting of capital gains realized on the sale of qualified small business corporation shares or qualified farm or fishing property (i.e. property that would be eligible for the lifetime capital gains exemption)
- Where amounts are paid to a person aged 24 or older who works more than twenty hours a week in the business in the year in question or in any five prior years
- Where amounts are paid to a person aged 24 or older who owns at least 10 per cent of the votes and value of shares of the corporation carrying on the business, except for professional corporations (i.e. legal, accounting and various medical practices) or certain other service businesses
- Where property is received by inheritance; in such case the recipient is put in the same place as the deceased owner as if the recipient was a continuation of the former owner
Individuals aged 25 or over who do not meet any of the above exclusions would be subject to a reasonableness test to determine how much income, if any, would be subject to the TOSI. In certain cases, adults aged 18 to 24 who have contributed to a family business with their own capital will be able to use the reasonableness test on the related income.
We believe the reasonableness test, although modified, will be difficult to apply in practice and in a tax audit context. To this end, the CRA has issued guidance in connection with these proposals, which they believe will ease the difficulty in applying the test.
The revised income sprinkling measures are proposed to be effective for the 2018 and subsequent taxation years. That said, the amendments effectively include a transition year whereby persons who wish to rely on the 10 per cent share ownership safe harbour exception have until the end of 2018 to organize their affairs.
The Department of Finance also confirmed its intention to move forward with proposals to limit tax deferral opportunities related to passive investments in a private corporation, the details of which will be included in the 2018 federal budget.
We recommend that you contact your RSM tax adviser to discuss the impact on you and any necessary or prudent next steps.