In July of 2017, the Department of Finance sent the Canadian tax community and business owners into a turmoil when they announced radical changes to the taxation of businesses and owners while most people were away for vacation. One of the initiatives which survived in a modified form was the Tax-on-Split-Income, reported in our posting “CRA Clarifies Proposed Income Splitting Rules”. Since the law was passed in June 2018, tax practitioners have found the rules to be extremely unspecific with glaring gaps for misunderstanding. These gaps could cost taxpayers millions of dollars in tax.
TOSI takes effect for 2018. To recap, TOSI applies tax at the highest marginal rate (ie. 46.8% for dividends, 53.5% for interest, 26.7% for capital gains) to any income that a business owner, a partner, or a trust, gives to non-active individuals. A business started by mom and dad, for example, which has children as shareholders would see the children taxed at the highest rate for any non-employment income they received from the business (ie. Dividends or capital gains). The same would be true for a brother and sister, where the brother or sister was the primary worker in the business and the other sibling received dividends. To add more salt to the wound, any TOSI income cannot be reduced by charitable donations or other losses! Among the few exceptions is an exception for individuals who have worked a substantial number of hours in the business, and an exception for individuals who have contributed capital to the business. Even these exceptions are “grey” and a case-by-case analysis is necessary. If you are a business owner and split income with your family members who are not involved in the business, you are likely affected.
Most small business owners do not have an RRSP or a formal pension plan, and the value they are building or have built in the business is their plan for retirement. Many owners have built up savings in their corporations which they have invested for their retirement. Now, any of that income that is split with their children, as most would want to do, could be taxed at the maximum rate (ie. 47% or 53.5%) and the children will be disallowed a deduction for charitable donations against that income.
On October 5, 2018, the CRA gave more guidance on how they plan to implement TOSI for the coming tax season. This guidance on October 5 was welcome input in what will likely be an involved learning process between practitioners and the CRA. This new guidance says, that if shareholders of investment businesses – those businesses formed specifically for earning income from passive assets – will be excluded from TOSI. This answered a major uncertainty about whether or not family wealth corporations would see their shareholders taxed at the highest rates.
But the story doesn’t end there. Complicating this is the news from CRA that one entity (corporation or partnership) can be deemed to be running more than one business at a time – requiring accounting which tracks those activities separately in order to determine TOSI! So, the family restaurant business, where mother and father accumulated their wealth and invested it, will be required to track their restaurant net income and their investment net income separately. This is an unprecedented record-keeping burden on multi-activity corporations. If left untended, a shareholder of that corporation who receives dividends could be surprised with a tax on their dividends of 53%. Or, the corporation could find themselves spending thousands of dollars responding to an audit of their records by CRA.
This is a very new ground for tax practitioners across the country. It is imperative that taxpayers obtain the most recent guidance available.
To find out where you stand and a free initial consultation, contact:
Jerry Paskowitz, CPA, CA, CMC, is a Partner with Sloan Partners with over 30 years’ experience in all tax and financial matters. Get in touch with Jerry by email or phone 416-649-7702 for an appointment to discuss tax savings opportunities and financial strategy for your business.