On December 13, 2017, the Minister of Finance announced the long-awaited update on the income sprinkling proposals. These proposals were originally announced on July 18th and received a lot of criticism from the public. The main goal was to limit the ability of business owners to split income with family members and reduce the overall tax bill. The Government viewed this practice as unfair. In response to the public outcry, the Ministry of Finance tweaked the original proposals and released the updated rules last week.
The new rules can be viewed as an improvement compared to the July 18th proposals. However, it would appear that the “tax on split income” or “TOSI, which results in the application of the highest marginal tax rate, could apply whenever there is a payment made to a related individual. However, the government introduced “bright-line” tests, which will automatically exclude individual members of a business owner’s family, who fall into any of the following categories:
- Business owner’s spouse, provided that the business owner meaningfully contributed to the business and is 65 or older.
- Adults aged 18 or over, who worked an average of 20 hours a week during the year or during any five previous years (need not be consecutive)
- Adults aged 25 or over who own 10% of more of a corporation that earns less than 90% of its income from the provision of services and is not a professional corporation.
- Individuals who receive capital gains from qualified small business corporation shares and qualified farm and fishing property, if they would not be subject to the highest marginal tax rate on the gains under existing rules.
- Aunts, uncles, nieces and nephews (not considered related for purposes of TOSI rules)
If individuals do not meet any of the above criteria, only then the reasonableness tests will apply to determine the portion of the income subject to TOSI. Canada Revenue Agency (“CRA”) stated in their comments (released concurrently) that as long as the taxpayer makes a “good faith attempt” to determine a reasonable return, then CRA will not substitute its judgment of what it would consider reasonable.
In addition, certain amounts received by a taxpayer would not be considered split income and therefore not subject to TOSI:
- Property received as a result of a marital breakdown
- Taxable capital gain from a deemed disposition resulting from the death of an individual
- Secondary income (income generated on the income which was subject to TOSI)
These new changes will be effective January 1, 2018; however business owners will have until the end of 2018 to arrange their affairs in order to comply with the new rules.
While these changes appear to be an improvement on the July 18th proposals, they will result in an increased compliance burden for most small business owners. Record keeping will become increasingly important under the new regime. It is a good idea to keep documentation relating to the hours worked by related individuals.
If you have any questions about how these changes will affect your business and your family, please contact S+C Partners LLP at 905-821-9215.