The federal government’s TOSI (Tax on Split Income) regulations came into force on 1 January 2019. In this article below, we have outlined how these changes will affect you and the potential steps you can take in light of the revised TOSI government rules. In case you find these overwhelming, talk to a personal tax accountant who can help you with tax services.
What is income sharing?
Income splitting is a tax strategy used in Canada to reduce a taxpayer’s overall tax burden by allocating income to low-income family members. The idea behind splitting income is to take advantage of Canada’s progressive tax system, which imposes higher tax rates on higher income levels. By targeting income to low-income family members, taxpayers can effectively reduce their total taxable income and lower their tax burden.
There are several methods and rules for dividing income in Canada, including:
Spousal loans: This is about lending money to a lower-income spouse or partner and you charge interest on the loan. The lower-income spouse can then claim the interest income, effectively dividing the taxpayer’s income.
Family trusts: A family trust is a type of trust that allows the income generated by the trust to be allocated to different family members. By using a family trust, taxpayers can direct income to low-income family members and reduce their overall tax bill.
Dividing Investment Income: Involves holding investments in the name of low-income family members. The income generated by these investments can then be claimed as low-income family income, effectively splitting the taxpayer’s income.
Talk to a personal tax accountant or an accounting firm for more clarity.
It is important to note that income distribution strategies in Canada are effective; must be done in accordance with Canadian tax laws and regulations. The CRA has rules that prevent taxpayers from artificially using income splitting to reduce their taxes, and taxpayers who engage in improper income splitting can face penalties and fines. If you’re looking for advice on how to reduce your taxable income in Canada, income splitting is a great option.
How does income sharing work in Canada now?
Previously, the TOSI only applied to the distribution of income to persons under the age of 18, but now the distribution of income to persons over the age of 18 will be subject to the TOSI. According to the Canada Revenue Agency (CRA), the distributed income of all people over the age of 18 will be taxed at the “highest marginal tax rate”. The new rules effectively eliminate the possibility of taking advantage of lower tax rates by splitting income with a family member in a lower tax bracket.
There are several exemptions to the Canadian Income Tax Act that business owners can take advantage of to get ahead. Note: In the examples below, the recipient of split income must be a close relative, i.e. a parent, child, or sibling, not an aunt, uncle, nephew, or niece.
What is TOSI-exempt in income sharing in Canada?
1. Corporate profits excluded
If the family member is aged between 18 and 24 and has worked an average of at least 20 hours a week for the company in the current tax year, his earnings are exempt from TOSI. You may also qualify for the exemption if you demonstrate a 20-hour week requirement in 5 prior tax years (these years do not have to be consecutive).
Furthermore, if the business operates only for part of the year (e.g. 6 months), it is sufficient to demonstrate the work contribution of a family member during that period. Not only income received in the tax years in which the person served is exempt from TOSI, but also dividends accrued after this period. This is useful when you want to convert an individual into a business.
For example, suppose a child worked in his parents’ bakery from the ages of 19 to 24 and then quit the day-to-day running of the business, but earned dividends from the ages of 25 to 28. Such dividends will be exempted by TOSI if deemed “reasonable”. This means that registration in the commercial register has many advantages for real estate agencies.
2. Shares are excluded
If the relative is at least 25 years old and owns at least 10% of the company both in votes and in value, his dividends are exempt from TOSI.
However, Finance Canada says the exemption will only apply to companies that “earn less than 90% of [their] revenue from providing services” and are not professional companies such as law firms, accounting firms, or dental and medical clinics.
3. Other exceptions
- Entrepreneurs over the age of 65
- The income distribution of spouses of entrepreneurs who have contributed to the business and those over 65 will not be subject to TOSI.
- Earnings from the sale of qualifying business interests, agricultural or fishing properties
- Distribute income from the sale of stock in a qualifying farm or fishery property or from the sale of stock in a qualifying small business (CRA).
The new rules are complex
The new TOSI exemption rules are not only complicated but could change in the coming years. From what constitutes a “wrongful return” to sufficiently documenting that your child or spouse worked for your company, there are many “grey areas” that you can’t leave to conjecture. Unfortunately, many companies have a lot of work to do when it comes to realigning the extended TOSI framework.
This article is just a brief look at the issue, but since every business is different and you have specific questions, your first step should be to speak to an accounting firm or a personal tax accountant for tax services who is fully aware of the legal environment and needs of your small business.
Whether it’s managing your company’s routine tax needs or retooling your organization to take advantage of new tax laws like TOSI, we’re ready to help with all kinds of tax services. We help you clarify your tax obligations so you can focus on growing your business.