Tax on Split Income – TOSI
Tax on split income (TOSI) applies to certain types of income received from a business.
Have you paid a dividend from your corporation to a non-active family member and are concerned about whether it will be taxed at the highest tax rate?
Here are a few helpful tips on how business owners and their family members can mitigate the impact of Tax on Split Income (“TOSI”) and Tax on Passive Income (“TOPI”) rules.
Certain types of dividends can be paid into a family trust and distributed to the beneficiaries or retain it in the trust for investment purposes. The funds retained in the trust can be invested. Income from the investment generated from the trust can be distributed to specific beneficiaries who will not be subject to Tax on Split Income (TOSI).
If you and your family members are holding the same class of equity shares in your operating company (or via a holding company) the Tax on Split Income (TOSI) rules might be restricting your ability to allocate dividends amongst the family members.
When a dividend is issued to a class of shareholders, everyone receives it based on their percentage of ownership.
You may want to gain flexibility by authorizing different classes of equity shares. Shareholders can then exchange their current equity shares for a different class of shares.
This strategy will allow dividends to be paid to individuals who are not subject to TOSI. The remaining shareholders, though not receiving dividends, can then exchange their current equity shares for a different class of shares.
This strategy will allow dividends to be paid to individuals who are not subject to TOSI. The remaining shareholders, though not receiving dividends, can participate in the growth of the company and possibly shelter a portion, or all, of their gain.
The shares of a private corporation held by certain family members must be of a Qualified Small Business Corporation (“QSBC”) at the time of disposition for such shareholders to utilize their Lifetime Capital Gain Exemption (“LCGE”) and not be subject to TOSI.
To meet the QSBC shares definition, they must generally be held for a period of 2 years, and the corporation must maintain a certain ratio qualifying assets to non-qualifying assets for two years and at the time of sale.
Ownership can still be structured to allow family members to participate in the growth of the company and utilize their available LCGE to shelter the capital gain resulting from the disposition of such shares.
However, in certain situations, the TOSI rules will reclassify the capital gain from the dispositions of non-QSBC shares to taxable dividend. Family members receiving such reclassified dividend will be deemed to have actually received TOSI income and as such be taxed at highest tax rate of 53.53% (for Ontario residents).
With careful planning, you can still leverage your LCGE and achieve up to $227,000 tax savings per family member.
The voting control of your private corporation might have been recommended for tax and non-tax reasons.
Now is the time to revisit the voting rights of your shares as giving up a portion of them may be the key to avoid the TOSI rules and allow dividend sprinkling with certain family members.
Individuals receiving a dividend must also be compliant with the TOSI rules as at the time of dividend payment.
It is time to review your corporate structure and reorganize your shareholdings as needed to allow income sprinkling with your family members.
You may have been informed that the TOSI rules prevent the payment of dividends from your operating company to your holding company and restrict dividend sprinkling with non-active family members.
Although this is true, the effects can sometimes be mitigated by the reorganization of capital, followed by an amalgamation and if necessary, a spin-off of assets to a new corporation.
Qualifying shareholders of private companies may be allowed to extract dividends at capital gain rates.
This arrangement results in the shareholder being taxed on half of the compensation received from the corporation.
The after tax-funds can be used to split income with non-active family members.
Shares of a corporation can be converted into other instruments which are not governed by the TOSI rules. With proper planning, non-active family members can subscribe for equity shares of your operating company and start receiving dividends once their equity shares have a 10% voting right and are equal to 10% of the value of your operating company.
Generally speaking, this strategy will not work for professional corporations or corporations whose income is 90% or more derived from the provision of services.
Tax on Passive Income – TOPI
Are you looking to crystalize gains or reallocate investable assets?
Before making such decisions, you should consider how the TOPI rules might affect you.
Look at the types of expenses you are incurring to earn investment income. These deductions will reduce the amount of passive income that will be caught by the new Tax on Passive Income (TOPI) rules.
This strategy allows you to preserve the corporation’s small business deduction.
You might, for example, switch to investments that appreciate in value instead of paying investment income. In doing so, you may trigger a larger than ordinary capital gain for that year and in turn your small business deduction limit might not be available for the next fiscal year; however, the non-taxable portion of capital gains generated will create a capital dividend account pool which can be utilized to circumvent the TOSI rules for certain non-active family members.
You can structure the payment of certain dividends to reduce the amount of investment income subject to TOPI, and minimize the tax implications for family members.
This strategy also preserves the corporation’s small business deduction.
In order to reduce income derived from rental properties, it might be beneficial to start taking capital cost allowance to reduce the income subject to TOPI.
This strategy helps to preserves the corporation’s small business deduction.
The TOPI rules restrict recovery of the refundable dividend tax on hand (“RDTOH”) account in certain situations. Pay particular attention to where RDTOH is present in one company while the general rate income pool (“GRIP”) is present in another. It is beneficial to ensure one entity has both the RDTOH and GRIP balance.
Corporations may want to consider using funds for the repayment of outstanding shareholder loans to individual shareholders, instead of using such funds for the purchase of passive income generating assets.
This strategy helps preserve the corporation’s small business deduction.
For corporations earning active business income, it might be advantageous to use corporate funds towards the repayment of corporate debt or the purchase of active business income generating assets (such as buildings, equipment, inventory and machinery) instead of being invested in passive income generating assets.
This strategy helps preserve the corporation’s small business deduction.
Looking for ways to reduce income subject to the TOPI rules? It might be beneficial to consider donating funds or investments with accrued capital gains.
The donations are deductible by the corporation to the extent there is taxable income (excluding income subject to TOPI rules).
