Income splitting (also known as income sprinkling) is a strategy that can be used by high-income owners of private corporations to divert their income to family members with lower personal tax rates, thereby decreasing the family’s tax burden overall.The federal government issued draft legislative proposals designed to limit income splitting on July 18, 2017. Prior to these changes, legislation imposed a tax on split income in order to disincentivize income-splitting arrangements with minor children who were residents of Canada.The tax on split income, as outlined in section 120.4 of the Income Tax Act, took effect on January 1, 2018. The new legislation expands the category of individuals subject to the TOSI to include children who are over 18 and other related adult individuals who are residents of Canada, as well as adding several exclusions.
Split income is defined in s. 120.4 as income from a nonpublic corporation, a partnership or a trust. It also includes the income or gain from the disposition of property that took place after 2017, where the income from that property would be subject to TOSI.The following is a summary of each condition and, if available, information on the subjective tests involved in determining eligibility. In the following list, the “individual” refers to the person who is receiving the split income. Income is considered exempt from TOSI if:
The sheer volume of exclusions outlined in section 120.4 makes the rules complicated to navigate, even for experts of the TOSI. The new regulations raise significant challenges for tax planning as they may have unexpected consequences for taxpayers, particularly if family businesses are carried out through holding or investment companies, or where shares are held by a family trust.Tax planning with the TOSI requires familiarity with the complete set of exclusions. Without familiarity with the numerous provisions, an income that falls under an exclusion could be improperly taxed. The consequences of not understanding whether income is taxable under the new rules are clear: split income is taxed at 33%, the highest marginal federal tax rate for 2019.The complexity and novelty of the TOSI, in combination with its tax consequences affecting a wide range of private business structures, present several challenges for tax professionals. The first, and most obvious, is the potential of taking a narrow view of the TOSI exclusions and missing potential applications in tax planning. Second, the process of checking novel tax situations against a complicated set of rules requires significant time and resources to ensure accuracy and compliance. Inefficiencies arising from navigating complicated legislation reduce the time available for other tasks that require more creative applications of expertise.
Developed in partnership with leading tax advisory firm Moodys, Blue J Tax’s new TOSI Guided Analysis allows tax professionals to circumvent those issues. This dynamic tool was designed to be an interactive and user-friendly version of the Moodys integral flowchart, which has been adopted as the industry standard for financial professionals across Canada.The TOSI Guided Analysis takes the user step-by-step through the regulations, addressing the inclusion and exclusion criteria and customizing its subsequent queries to the user’s particular tax situation as more questions are answered. The process eliminates potentially confusing factors that are inapplicable in each unique tax situation and only asks questions that are relevant to clarifying whether the relevant income is subject to the TOSI.Using the Guided Analysis provides many benefits for tax practitioners. It eliminates inefficiencies in the process of determining whether exclusions apply, allowing users to work more efficiently and accurately. No longer overtasked with inefficient navigation of legislation, professionals can turn their attention to applying more of their expertise to clients’ situations. The Guided Analysis also incorporates CRA interpretations for better comprehensibility and quality assurance, allowing professionals to increase their mastery of the legislation and ensure efficient, accurate client advice.
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