One way for your business-owner client to avoid the tax on split income (TOSI) is with the excluded shares exemption, so long as the business isn’t a professional corporation nor primarily a services business. On its website, CRA provides examples of businesses that do or don’t meet the exemption, based on a test related to gross business income.
The TOSI rules, which were expanded in 2018 to include adults and more types of income, determine whether someone will be taxed at the highest marginal tax rate on income derived from a business.
Read: Make TOSI less taxing for your business-owner client
Generally, TOSI could apply where someone receives dividends or interest—or realizes a capital gain—from a private corporation, and a family member is actively engaged in the corporation’s business or holds at least 10% of its value. An example is where children receive dividends from a business owner who is their parent.
Under the excluded shares exemption, for family members age 25 or older, TOSI doesn’t apply if they can check off all these items:
- The family member personally owns 10% or more of the votes and value of the business.
- The business isn’t a professional corporation.
- Less than 10% of the business’s income in the previous tax year was derived from another related business.
- Less than 90% of the corporation’s gross business income in the previous tax year was from providing services.
The first three criteria are more clear-cut than is the last, and that’s where CRA’s examples help.
Below are highlights from the examples that your client might need to know if they want to meet the 90% test. CRA’s examples assume that the first three criteria above have been met; that the corporation has a Dec. 31 year-end and; that a dividend has been paid by the corporation to a family member in 2018.
Whether a business is a services business or not can vary yearly
A business might have a year when less than 90% its gross business income comes from services—and therefore TOSI wouldn’t apply—and another year when it doesn’t.
Consider a plumbing business that makes repairs and also operates a retail store selling parts separately to customers (i.e., the parts aren’t used by the business in providing its services).
In two different years, the provision of services results in income of $950,000 and $900,000, respectively, and retail sales result in income of $50,000 and $300,000, respectively. As a result, gross business income in the two years is $1 million and $1.2 million respectively.
Based on these figures, Table 1 shows that services make up 95% and 75% of gross business income in each respective year. As a result, TOSI wouldn’t apply on the 2019 tax return, but would apply on 2018’s.
Table 1: Determining if less than 90% of gross business income comes from services
|Income from services (A)||$950,000||$900,000|
|Gross business income (B)||$1,000,000||$1,200,000|
|90% test (A ÷ B)||95%||75%|
Don’t subtract the cost of incidental goods
Another issue is whether goods used to provide services can be subtracted from the services part of gross business income as a way to lower the proportion of income coming from services. Your client shouldn’t attempt this workaround because CRA won’t allow it.
Consider a cleaning company with income of $1 million from services (Table 2). Although the company spends $150,000 on cleaning products used when providing its cleaning services to customers, that cost isn’t subtracted from the services part of its gross business income because the products are incidental to the services, CRA says on its website.
Further, the cleaning products are still considered incidental to the services provided even if the business goes to the trouble of separately listing an amount for the cleaning products on customers’ invoices, it says.
Table 2: Determining if less than 90% of gross business income comes from services when incidental goods are used
|Income from services (A)||$1,000,000|
|Gross business income (B, where A = B)||$1,000,000|
|Cost of cleaning products (incidental to providing services)||$150,000|
|90% test (A ÷ B)||100%|
A different outcome can occur where a business has income from both services and non-services.
Consider a cleaning business where cleaning products are sold to retail customers who aren’t customers of the service business, or where the cleaning products are sold to customers when they buy cleaning services. In such cases, the sale price allocated to cleaning products isn’t included as services income in applying the gross business income test, CRA says.
If gross income in 2018 is $1 million — say, $800,000 from services and $200,000 from product sales — the gross business income test would be 80% ($800,000 ÷ 1,000,000), and the corporation would be exempt from TOSI on its 2019 tax return.
Distinguish income from services and non-services
For some businesses, separating income from services and income from non-services will be more complicated.
Consider a construction business that offers deck construction and repair, with the business supplying all labour and materials. The resulting income includes a services component (labour) and a non-services component (materials).
The latter must be removed from gross business income so as to identify the income derived from services when applying the gross business income test, CRA says.
For numerical details that illustrate such a case, see Example 6 on CRA’s website.
The CRA website says consultations on TOSI are ongoing and more examples could be added to its website.
CRA talks TOSI at STEP Canada roundtable