Bakery owners
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Owners of private corporations must be careful when paying dividends to shareholders who are family members. Under the tax on split income (TOSI) rules expanded in 2018, those 18 and over who receive dividends from a family corporation may be taxed at the highest marginal tax rate, unless they meet certain tests based on their business contributions or qualify for other TOSI exceptions.

Recent technical interpretations by the CRA provide some clarity on where TOSI may not apply.

No business means no TOSI

The CRA confirmed that if a private corporation earns income from property, such as rental property and investments, and not from carrying on a business in the current tax year, TOSI wouldn’t apply to dividends paid to family members age 18 and over. This is good news for passive investment corporations.

However, there’s no objective test to determine when the CRA considers a private corporation to be earning income from property as opposed to income from business.

The CRA typically applies a subjective test that looks at various aspects of the investment corporation, including the number, volume, nature and frequency of transactions.

If challenged by the CRA, your client must prove the corporation wasn’t carrying on a business. It may thus be prudent to err on the side of caution and assume the corporation carries on a business unless a clear distinction can be made.

No TOSI after selling an operating business — but timing matters

The CRA confirmed that TOSI wouldn’t apply after the sale or dissolution of an operating business where shares meet the excluded shares exception. The criteria to meet the excluded shares exception are listed in 120.4 (1) of the Income Tax Act.

The CRA considered a hypothetical situation where Mr. A and Mrs. A are married and both over age 25. They each own 50% of the votes and value of ACo. Mrs. A was actively engaged in ACo’s business on a regular, substantial and continuous basis for at least five years in the past, and Mr. A made no business contributions. ACo sold its operating business two years ago (year two), and the sale proceeds and retained earnings were invested in public securities.

Under the excluded shares exception, the CRA clarified that the timing of dividend payments is an important factor in determining whether TOSI applies. For example, if dividends were paid in year three, the corporation would need to qualify for the excluded shares exception based on income in year two.

Assuming ACo is deemed to be carrying on an investment business due to its activity level, ACo shares will qualify as excluded shares starting in year four, and dividends received by Mr. A in that year wouldn’t be subject to TOSI for the following reasons:

  • ACo didn’t earn business income from services in year three, and isn’t a professional corporation.
  • Mr. A owns 50% of ACo’s votes and value.
  • ACo’s income in year three wasn’t derived from a related business (other than ACo’s business).

If ACo didn’t have a sufficient level of activity to be carrying on a business in year three and onward (i.e., all business activities ceased in year two with the sale of the operating business), TOSI generally wouldn’t apply to dividends received by Mr. A in year three and onward, as the dividends would be considered an excluded amount. That’s because ACo’s income for the year is from property, not from a related business, as discussed above.

Given the complexity of the rules, advisors should work with clients before they pay dividends to family members to determine if they’ll be subject to TOSI.

Vivek Bansal, CPA, CA, is director of tax and estate planning at Mackenzie Investments. He can be reached at