25 What is the Tax on Split Income? What are the tax implications? Why does it exist?

ITA S.120.4 – Tax on Split Income (TOSI), is an anti-avoidance method that is designed to prevent private corporations from splitting income with adult and/or minor family members.  The TOSI rules are complex but, in general, TOSI applies to “split income” received by a “specified individual” from a “related business”.  These terms will be defined further below.

Currently, the TOSI applies the highest marginal tax rate of 33% on the following who receive split income:

• minors under the age of 18,
• children age 18 and over, and
• certain other related adult individuals (including spouses or common-law partners, grandparents, and grandchildren, but not aunts, uncles, nephews, or nieces).

A specified individual, for a taxation year, means an individual (other than a trust) who is either resident in Canada or, if the individual has not attained the age of 17 years before the year, has a parent resident in Canada at any time in the year.

A related business generally exists when a related person is active in the business on a regular basis or owns at least 10% of the fair market value of the shares in a corporation that carries on the business.

Split income generally includes income derived directly or indirectly from a related business, such as taxable dividends, shareholder benefits, or interest income, but not salary, paid in respect of the individual and certain capital gains unless the amount is an “excluded amount”.

Excluded amounts are income received by an individual that TOSI will not apply to, and some examples include amounts received on:

• Inherited property
• The death of a spouse/common-law partner before end of the year
• As a result of breakdown of marriage or common-law partnership;
• Taxable capital gains deemed to be realized on death;

Example:

Natasha is 5-years old.  Her mother owns a CCPC and last year she gave Natasha shares in the company.  This year the company pays Natasha $10,000 in non-eligible dividends.  What is the tax implication?

Answer:

Natasha’s federal tax is calculated using the highest marginal rate of 33% instead of the normal 15%. Her total federal tax on this income is $11,500 ($10,000 + 15% grossup) x 33% = $3,795.

If Natasha had been taxed at the normal federal tax rate of 15%, her tax would have been $11,500 x 15% = $1,725. Natasha would’ve paid less than half in taxes if TOSI was not in place.  It’s also important to note that TOSI restricts the tax credits that can be claimed.  Only the dividend tax credit, foreign tax credit (related to the TOSI income) and the disability tax credit can be applied.  She wouldn’t even be able to use her Basic Personal Amount credit against the tax payable on the TOSI income.

Interactive content (Author: Karn Thiara, January 2020)

References and Resources:

• Article – “Federal tax on split income” (Author: Government of Canada)