The legislative proposals tabled on July 18 are still being discussed. Indeed, the Minister of Finance tabled a new draft of legislative proposals on December 13. That’s why we’re presenting you with the third chapter on this subject, following on from the articles entitled “Tax planning using private corporations” and “Latest changes following the July 18 legislative proposals” that were recently published in InfoCPA.
It should be remembered that the Minister of Finance wishes to limit income splitting between family members where there is no contribution of labour or capital, or where no financial risk is assumed by the individual. These measures apply, among others, to dividends, interest, income from the disposition of property and capital gains. However, it is important to note that capital gains arising from the sale of qualified small business corporation shares by an individual, or that are designated by a trust to a beneficiary, are not subject to these rules. In addition, assets inherited through the death of another person will not be subject to the split-income rules, subject to certain conditions.
The documents tabled by Minister Morneau clarify the application of the split-income tax by considering four specific situations: individuals aged 18 and over, individuals aged between 18 and 24, individuals aged 25 and over, and additional relief for spouses. For ease of understanding, each of these categories is discussed separately in the following text.
Individuals aged 18 and over
The basic principle is that any distribution from a corporation to a family member 18 years of age or older is considered split income, unless it falls under one of the exceptions listed below. The exceptions that apply to this category include two specific situations, namely a business other than a related business or an excluded business.
Non-affiliated company
First, the income-splitting rules will apply only where there is a related business. In general terms, this definition is met when an individual is related to a person who is actively engaged in the business, or that person owns shares having a fair market value greater than 10% of the total fair market value of the corporation. Thus, in a situation where there is no related business, the split income tax does not apply.
Excluded company
In addition, the income-splitting rules will not apply when the amount is derived from a business in which the individual is actively engaged on a regular, continuous and substantial basis, either in the current taxation year or in five previous taxation years (consecutive or not). In general, an individual is actively engaged on a regular, continuous and substantial basis in a taxation year if he or she works for the business at least 20 hours per week. Note, however, that gains realized on the disposition of company shares will be excluded from the split-income rules only if the individual satisfies the five-prior-year test.
Individuals aged between 18 and 24
In addition to the exceptions mentioned in the previous section, individuals between the ages of 18 and 24 will not be subject to tax on split income in the presence of an exempt return and on the individual’s independent capital contributions.
Exempt yield
In fact, it is permissible to allocate an amount to a family member when it is an exempt return in relation to his or her capital contribution. This return must not exceed the current prescribed rate on the fair market value of the invested assets.
Independent capital
In addition, the individual will be entitled to a reasonable return on capital contributions from the individual’s own independent capital. To do so, the money must not come from a family member, must not have been borrowed, and must not have been acquired as a dividend from a related company. Generally speaking, an individual’s independent capital is property earned, inherited or acquired by the individual.
Individuals aged 25 and over
Like the two categories mentioned above, any distribution received by an individual aged 25 or over is considered split income, unless subject to an exception. In addition to the above exceptions, there are two other exceptions: excluded shares and reasonable return.
Excluded shares
The income-splitting rules will not apply when the family member holds more than 10% of a corporation’s shares in terms of voting power and value. To use this exception, the percentage of business income derived from the provision of services must represent less than 90% of total income. In addition, a maximum of 10% of service income may be derived from another related corporation. Finally, the company must not be a professional corporation.
Reasonable return
As previously discussed, an individual between the ages of 18 and 24 may be allocated an amount with no tax consequences when it is an exempt return or a reasonable return in relation to the individual’s independent capital. For family members aged 25 and over, this exception also applies, and is enhanced. In this case, the reasonable return is considered in light of all the following criteria: work performed, contributions made, risks assumed, amounts paid or any other factor deemed relevant.
Spouse
The rules applicable to spouses are the same as those mentioned above. However, an exception has been added by the Minister of Finance that applies specifically to spouses. Where an individual is not subject to the income-splitting rules and is over age 65, the income-splitting rules will not apply to his or her spouse as well. This rule has been introduced to harmonize with the current pension income splitting rule.
Conclusion
The new rules presented in this article will be applicable as of January1, 2018. For this reason, it’s a good idea to maximize income splitting with family members who have reached the age of majority by December 31, 2017, in order to reduce your tax bill before the above rules apply.
Starting in 2018, a legislative headache will be implemented so that a business owner can continue to split with adult family members.
We’ll be back in the coming weeks with more specific examples of these new proposals.
[a-team-showcase id=”3615″]
