Tax Update #6
On December 13, 2017, the Department of Finance released its long awaited revised legislative tax proposals targeting “income sprinkling” by private corporations.
The original July 18th proposals were met with unprecedented criticism and concerns over fairness, complexity and unintended consequences. In response, during the week of October 16th to 20th, the Federal Government made a series of announcements indicating its intention to retreat from the proposals limiting the lifetime capital gains exemption and preventing the “conversion of income into capital gains”, but to proceed with the “income sprinkling” and passive investment income proposals. Revised, simplified “income sprinkling” legislation – effective January 1, 2018 – was promised for this fall, and the passive investment income legislation is expected as part of the 2018 Federal Budget.
Davis Martindale’s tax professionals have analyzed the December 13th draft legislation, and while it is an improvement over the original July 18th version, the draft legislation is still very complex, and rife with subjective tests and ambiguity. We had hoped to see “bright-line” tests – that’s how Finance describes these changes in its published materials – but we think that they have fallen short.
In this Tax Update, we provide an overview of the December 13th “income sprinkling” tax proposals. For those interested, a more “technical” analysis will be available on our website.
As always, your Davis Martindale advisors are available and ready to assist you!
December 13, 2017 Proposed Amendments – “Income Sprinkling”
Finance first introduced “tax on split income” (“TOSI”) in 1999 in order to eliminate the benefit of income splitting with minor aged individuals.
If the TOSI rules apply to income received by an individual, that income will be taxed at the highest marginal personal rate, regardless of the income level and tax bracket of the recipient.
Starting in 2018, the TOSI rules will be expanded in two main ways:
- The rules will potentially apply to anyone, regardless of age (i.e., it is no longer just a “Kiddie Tax”); and
- Additional types and sources of income will be subject to TOSI.
First of all, there are certain situations where TOSI will never apply:
- Taxable capital gains deemed to occur on death;
- Taxable capital gains that are eligible for the capital gains exemption for Qualified Small Business Corporation shares or Qualified Farm Property[i]. This includes taxable capital gains realized through a trust. And, unless the individual is under age 18, it also includes non-arm’s length transactions; and
- Income or gains on property transferred due to the breakdown of a marriage or common-law partnership.
Recipients Age 18 or Older
For all adults, if the amount received[ii] is not derived from a business of a related individual, TOSI will not apply. “Related” for tax purposes includes only spouses, common-law partners, siblings, parents, children (and grandchildren, etc.).
If an amount received is derived from a related business, TOSI will not apply if, during the year, or any five prior years, the recipient worked in the business at least an average of 20 hours per week.
Recipients Age 25 or Older
The TOSI rules will not apply to income or taxable capital gains from private corporate shares owned by an individual age 25 years or older if the following conditions are met:
- The corporation is not a professional corporation and less than 90% of its business income is from the provision of services; and
- The individual owns shares representing 10% of the votes and 10% of the fair market value of the corporation.
- Work performed;
- Property contributed;
- Risks assumed; and
- Other factors that may be relevant in the circumstances.
Recipients Age 18 to 24
Exceptions for individuals age 18 to 24 are more limited. An amount received will not be subject to TOSI if it is a reasonable return, taking into consideration only the recipient’s contribution of capital, relative to the contributions of the related individual. For this purpose, contributed capital will not include borrowed funds (including arm’s length borrowings), amounts transferred from related individuals (other than an inheritance), or amounts derived from a related business.
If the individual contributes capital, but it does not meet these conditions, the amount subject to TOSI will be reduced by an amount that is equal to the Canada Revenue Agency’s prescribed rate applied to the contributed capital.
Recipients Under Age 25
If a recipient is under age 25, amounts received from inherited property will not be subject to TOSI if the property is received from a parent. If the property is inherited from any other person, TOSI will not apply if the recipient is a full-time post secondary student, or is eligible for the disability tax credit. It is important to note that once the individual reaches age 25, this exception will no longer apply.
Recipient’s Spouse is Age 65 or Older
In order to better align the TOSI rules with the pension income splitting rules, an amount received will not be subject to TOSI if the recipient’s spouse is age 65 or older (or deceased), and the amount would not be subject to TOSI if it was hypothetically received by the recipient’s spouse.
[i] Assuming all conditions are met.
[ii] Throughout this discussion, “amount received” refers to any income, taxable capital gain or profit.