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In The News

Finance Department Clarifies Income Sprinkling Measures


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Back in July, the Department of Finance released a consultation paper, along with some proposed legislation, focused on tax planning using private corporations. The government believes that some business owners were taking unfair advantage of the existing rules surrounding the taxation of corporations to reduce their tax burden.

One of the key issues addressed in the paper concerned income sprinkling. Several measures were introduced to eliminate the benefit of splitting income with family members in order to prevent business owners from sprinkling income to family members who were not, in fact, contributing to the business. The measures introduced proved to be highly controversial.

On December 13, the Department of Finance released legislation to simplify restrictions on income sprinkling in response to feedback received from Canadians during the consultation period. In addition, the Canada Revenue Agency (CRA) released guidance with respect to these measures.

Income Sprinkling – Clarifying the Rules

The amendments introduced on December 13 are intended to clarify whether a family member contributes to a business, and thus potentially exempt from being taxed at the highest marginal tax rate on amounts derived from that business (referred to as the “tax on split income” or “TOSI”).

Exclusions

The Department of Finance introduced a number of “bright-line” tests – or off ramps – that automatically excludes certain individuals from the income sprinkling rules. If a member of a business owner’s family falls under any of these categories, they will be excluded from the income sprinkling rules:

  • A family member who is the business owner’s spouse, provided that the business owner meaningfully contributed to the business and is aged 65 or over.
  • A family member who is 18 or over that has made a substantial labour contribution to the business (generally an average of at least 20 hours per week) during the year, or during any five previous taxation years.
  • The family member is 25 or older who own 10% or more of the business (votes and value) that earns less than 90% of its income from services and is not a professional corporation.
  • Individuals who realize capital gains from qualified small business corporation shares and qualified farm or fishing property, provided that they would not be subject to the highest marginal tax rate on the gains under existing rules. In addition, capital gains arising on an individual’s death or income or gains from property received as a settlement due to marriage breakdown.

Individuals aged 25 or over who do not qualify for the above exclusions would be subject to a reasonableness test to determine how much income, if any, would be subject to the TOSI. In certain cases, adults aged 18 to 24 who have contributed to a family business with their own capital will be able to use the reasonableness test on the related income.

Key Dates and Other Considerations

These measures will apply to the 2018 and subsequent taxation years. However, the officials from the Department of Finance pointed out that while the rules go into effect on January 1, 2018, businesses have until December 31, 2018 to adjust to the changes before filing their 2018 taxes.

The Department of Finance also reiterated in their recent announcement that: “The Government will also move forward with measures to limit tax deferral opportunities related to passive investments, and details of that plan will be included in Budget 2018. When introduced, the passive investment measures will apply only on a go-forward basis.”


Disclaimer: The information provided in this article is intended for general purposes only. Care has been taken to ensure that information herein is accurate; however no representation is made as to the accuracy thereof. The information should not be relied upon to replace specific professional advice.