The TOSI Rules What s new?

Transcription

1 The TOSI Rules What s new? Règles relatives au fractionnement du revenu Quoi de neuf? November 16, 2018 Katherine Borsellino, LL.B, J.D., LL.M (Fisc.) Emilie Champagne-Couillard, LL.B, D.E.S.S. (Fisc.) Richter LLP Montreal

2 Tax on Split Income (Kiddie Tax) Pre 2018 Purpose Limit and/or eliminate income splitting with minor children Application Canadian resident individual under the age of 18 ( Specified individual ) Earning certain forms of income from a private corporation, partnership or trust ( Split income ) Exception for certain Excluded amounts Consequence Income is subject to the highest individual tax rate Certain personal tax credits are denied 2

3 Tax on Split Income (TOSI) As of 2018 Purpose Limit and/or eliminate income splitting with minors Limit and/or eliminate income splitting with adults Definitions MODIFIED / EXPANDED DEFINITIONS MODIFIÉES / ÉTENDUES NEW / NOUVELLES DEFINITIONS Excluded amount / Montant exclu Specified individual / Particulier déterminé Split income / Revenu fractionné Arm s length capital / Capital indépendant Excluded business / Entreprise exclue Excluded shares / Actions exclues Reasonable return / Rendement raisonnable Related business / Entreprise liée Safe harbor capital return / Rendement exonéré Source individual / Particulier source 3

4 TOSI Application Specified individual/ Particulier déterminé Individual (other than a trust) who is a resident in Canada (at the end of the year or immediately before their death); or Minor who has a parent resident in Canada at any time of the year Split income / Revenu fractionné Dividend income (or shareholder benefit) derived from a [private] corporation Capital gains derived from the disposition of shares of a [private] corporation, an interest in a partnership or trust or a debt obligation Certain partnership income and capital gains derived from a related business or the rental of property (where a related person is actively engaged on a regular basis in the activities related to the rental of property) Certain trust income and capital gains derived from a related business or the rental of property (where a related person is actively engaged on a regular basis in the activities related to the rental of property) Certain interest income derived from a [private] corporation, partnership or trust 4

5 TOSI Application Related business / Entreprise liée Business carried on by a source individual Business carried on by a partnership, corporation or trust if a source individual is actively engaged on a regular basis in the activities of the partnership corporation or trust Business of a partnership if the source individual has an interest in the partnership (directly or indirectly) at any time during the year Business of a corporation if a source individual owns shares or property representing 10% or more of the FMV of the shares of the corporation 5

6 TOSI Application Source individual / Particulier source Individual (other than a trust) who is a resident in Canada and is related to the specified individual Related para. 251(2)a) Deemed not related if living separate and apart because of marriage or common-law relationship breakdown para (1.1)(e) Consequence Income is subject to the highest individual tax rate 120.4(2) Certain personal tax credits are denied 6

7 TOSI Exceptions Income, capital gain or profit to the extent that such amounts qualify as an excluded amount Inheritance Source individual who is

8 Example Settlor: 3 rd party Trustees: Founder 3 rd party non-settlor, non-beneficiary Beneficiaries: Founder (source individual and specified individual) Spouse (specified individual) Child 1 (25 +) - full time (source individual and specified individual) Child 2 (18-24) - part time (specified individual) Child 3 (minor) (specified individual) Corporations controlled by Founder 8

9 During Operations Employment Income TOSI does not apply to employment income General limitations when computing income will apply Income producing purpose (para. 18(1)(a)) Non-capital expense (para. 18(1)(b)) Reasonable (section 67) Shareholder benefit (section 15) 9

10 During Operations Dividend Income Excluded Amount Non-Related Business / Entreprise non liée (120.4(1)(e)(i)) SPECIFIED INDIVIDUAL CONDITIONS OF APPLICATION X Founder X Spouse X Child 1 (adult, 25+) X Child 2 (adult, 18-24) X Child 3 (minor) > 17 years old x Not derived, directly or indirectly, from a related business for the year Business carried on by a source individual (or) Business carried on by a corporation where a source individual is actively engaged on a regular basis Business of a corporation if a source individual owns shares or property representing 10% or more of the FMV of the shares of the corporation 10

11 During Operations Dividend Income Excluded Amount Excluded Business [for the year] / Entreprise exclue (120.4(1)(e)(ii)) SPECIFIED INDIVIDUAL CONDITIONS OF APPLICATION Founder X Spouse Child 1 (25+) ~ Child 2 (18-24) X Child 3 (minor) > 17 years old Individual is actively engaged on a regular, continuous and substantial basis in the activities of the business in the current year or any 5 prior taxation years Depends on the facts and circumstances 120.4(1.1)(a): Deeming rule where individual works at least an average of 20 hours per week during the portion of the year in which the business operates Any 5 prior taxation years of the specified individual 11

12 During Operations Dividend Income Excluded Amount Excluded shares / Actions exclues (120.4(1)(g)(i)) SPECIFIED INDIVIDUAL CONDITIONS OF APPLICATION ~ Founder X Spouse X Child 1 (25+) X Child 2 (18-24) X Child 3 (minor) > 24 years old Shares owned by the specified individual if: a) (i) Less than 90% of the business income of the corporation was from the provision of services (ii) the corporation is not a professional corporation (accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor) b) the specified individual owns shares that represent 10% or more of the votes and FMV c) all or substantially all of the income for the year is not derived, directly or indirectly, from one or more other related businesses other than a business of the corporation 12

13 During Operations Dividend Income Excluded Amount Safe Harbour Capital Return / Rendement exonéré (120.4(1)(f)(i)) SPECIFIED INDIVIDUAL CONDITIONS OF APPLICATION X Founder X Spouse X Child 1 (25+) ~ Child 2 (18-24) X Child 3 (minor) years old Return up to the highest prescribed rate of interest in effect for a quarter in the year 2% as of April 2018 FMV of property contributed in support of the related business Pro rata according to the number of days in the year that the property (or substituted property) is used in support of the business Within the safe harbour: TOSI does not apply Amount exceeding the safe harbour: TOSI does apply 13

14 During Operations Dividend Income Excluded Amount Reasonable Return / Rendement raisonnable (120.4(1)(g)(ii)) SPECIFIED INDIVIDUAL CONDITIONS OF APPLICATION Founder X Spouse Child 1 (25+) X Child 2 (18-24) X Child 3 (minor) > 24 years old Amount derived directly or indirectly from a related business Reasonable having regard to the relative contributions of the specified individual and each source individual in support of the related business a) Work performed b) Property contributed c) Risks assumed d) Historical payments e) Other relevant factors Reasonable amount: TOSI does not apply Unreasonable amount: TOSI does apply 14

15 During Operations Dividend Income Excluded Amount Reasonable Return Arm s Length Capital / Rendement raisonnable capital indépendant (120.4(1)(f)(ii)) SPECIFIED INDIVIDUAL CONDITIONS OF APPLICATION X Founder X Spouse X Child 1 (25+) X Child 2 (18-24) X Child 3 (minor) years old Reasonable Return Limited to contributions of arm s length capital, being property contributed by the specified individual that was not Derived, directly or indirectly, from a related business Borrowed under a loan or indebtedness Transferred, directly or indirectly by any means whatever, from a related person (other than as a consequence of death) Reasonable amount: TOSI does not apply Unreasonable amount: TOSI does apply 15

16 Upon the Sale of Opco and/or Holdco Excluded Amount Capital gain realized on the disposition of shares that qualify as excluded shares Capital gain realized on the disposition of an excluded business Capital gain realized on the disposition of a non-related business 16

17 Upon the Sale of Opco and/or Holdco Excluded Amount QFFP or QSBC (120.4(1)(d)) No age limitation A taxable capital gain from the disposition of qualified small business corporation ( QSBC ) shares and qualified farm or fishing property ( QFFP ) will not be subject to TOSI Preserves the availability of the lifetime capital gains exemption ( LCGE ) This exception is not applicable to a taxable capital gain that is deemed to be an ineligible dividend under subsection 120.4(4) or (5) minors only Deemed dividend is subject to highest individual tax rate but dividend tax credit is not denied The LCGE will be available to minors if there is a disposition to an arm s length party The LCGE will be available to minors if a capital gain arises as a consequence of death 17

18 Upon the Breakdown of a Marriage or Common-law Partnership Excluded Amount The Break-up Exception (120.4(1)(b)) No age limitation Property acquired by a spouse following the breakdown of a marriage or commonlaw partnership The income derived from said property will not be subject to TOSI Decree, order or judgement of a competent tribunal or a written separation agreement; and The taxpayer and their spouse or common-law partner were separated and living apart as a result of the breakdown of their marriage or common-law partnership 18

19 Example Settlor: 3 rd party Trustees: Founder 3 rd party non-settlor, non-beneficiary Beneficiaries: Founder (source individual and specified individual) Spouse (specified individual) Child 1 (25 +) - full time (source individual and specified individual) Child 2 (18-24) - part time (specified individual) Child 3 (minor) (specified individual) Corporations controlled by Founder 19

20 Upon the Retirement of Founder (+65 years old) Founder (see previous slides) Excluded business Reasonable return Does this still apply? Spouse No excluded amount exceptions are applicable Baby Boomer Exception (120.4(1.1)(c)(i)) Founder is +65 years old TOSI does not apply to Founder due to an excluded amount TOSI will not apply to the spouse or common-law partner of Founder 20

21 Upon the Retirement of Founder (+65 years old) Child 1 (25+) (see previous slides) Excluded business Reasonable return Child 2 (18-24) (see previous slides) Excluded business? Safe Harbor Capital Return? Child 3 (minor) (see previous slides) No excluded amount exceptions are applicable 21

22 Upon the Death of Founder Excluded Amount Capital gains on death (120.4(1)(c)) Founder No age limitation Taxable capital gains realized upon death are not subject to TOSI 22

23 Upon the Death of Founder Excluded Amount Inheritance (120.4(1)(a)) SPECIFIED INDIVUDAL (HEIRS) EXCLUDED AMOUNT INHERITANCE EXCEPTIONS Children < 25 years Income from property inherited from a parent Others < 25 years Income from property inherited from anyone if fulltime student enrolled in a post-secondary institution or eligible for the disability tax credit 23

24 Upon the Death of Founder Other Inheritance Exceptions Continuity Rules SPECIFIED INDIVIDUAL (HEIRS) EXCLUDED AMOUNT INHERITANCE EXCEPTIONS Children > 17 years Others > 17 years (120.4(1.1)(b)) Continuity rule for inherited property Reasonable Return: contributions of the deceased will be those of the heir Excluded Business: if the deceased was actively engaged on a regular and continuous basis, the heir will be deemed to be as well Excluded Shares: if the deceased held excluded shares, the heir will be deemed to have attained age 24 before the year Income earned from inherited property will not be subject to TOSI 24

25 Upon the Death of Founder Other Inheritance Exceptions Continuity Rules SPECIFIED INDIVIDUAL (HEIRS) EXCLUDED AMOUNT INHERITANCE EXCEPTIONS Spouse (120.4(1.1)(c)(ii)) Continuity rule for inherited property Income earned from inherited property will qualify as an excluded amount for the spouse if it was an excluded amount for the deceased 25

26 Recent Technical Interpretations 26

27 8 May 2018 Roundtable, C6 CALU Conference Question 6 Tax on Split Income Excluded Amount Excluded Shares Question 6(a): What is included as income from the provision of services? Whether a business will be considered to be engaged in the provision of services will depend of the facts and circumstances of the business Question 6(b): Can shares of a holding corporation qualify as excluded shares? The definition of excluded shares should generally not include shares of a holding company because, in the case of a holding corporation, all or substantially all of the income would be derived from a related business (other than a business carried on by the holding corporation) 27

28 May 29, 2018 STEP Q. 5 Split Income Definition of excluded shares What does income and business income mean? Distinction to be made between business income (para. (a)(i) of excluded shares) and income (para. (c) of excluded shares) Business income will depend on the facts and circumstances Income refers to any source of income Generally means GROSS income What if a corporation has income from the provision of both services and non-services? The income should be computed separately The non-service income should be taken into account in determining whether shares are excluded shares UNLESS the income can reasonably be considered to be necessary but incidental to the provision of the services 28

29 May 29, 2018 STEP Q. 6 Split Income Can shares of a Holdco qualify as excluded shares? Can shares of a holding company qualify as excluded shares? Generally, no, since all or substantially all of the income [of Holdco] is derived from a related business [Opco] (other than a business of Holdco). CRA confirms that, although the excluded shares exception does not apply, another exclusion can apply. Example: TOSI will not apply if it is a non-related business or an excluded business of the specified individual or if the income constitutes a reasonable return. However, CRA indicates that the most appropriate test to determine the non-application of TOSI should be based on the general test of whether the amount received is a reasonable return. 29

30 May 29, 2018 STEP Q. 7 Split Income Excluded shares and business income If a corporation does not have any business income, can its shares qualify as excluded shares? No Condition in subpara. (a)(i) states that less than 90% of the business income is from the provision of services; therefore, the corporation must have business income to test (Services Income) < 0.9 (Business Income) If both services income and business income = zero, the condition has been failed. 30

31 October 2018 APFF Roundtable Q. 9 Excluded shares Question 9(a): Can shares of a Holdco qualify as excluded shares? > If Holdco carries on a business: the shares of Holdco may qualify as excluded shares Business is not defined but the concept can expand to the undertaking of any kind (248(1)) The principal purpose of a business may be to derive income from property (interest, rents, dividends, royalties) > If Holdco does not carry on a business: the shares of Holdco cannot qualify as excluded shares If income from Holdco does not derive directly or indirectly from a related business, TOSI does not apply (non-related business exception) 31

32 October 2018 APFF Roundtable Q. 9 Excluded shares Question 9(b) and (c) Mrs. Mr. Holdco Opco 32

33 October 2018 APFF Roundtable Q. 9 Excluded shares Question 9(b) Holdco s only revenue in the year derives from dividends from Opco Mrs. X would not own excluded shares because all or substantially all of Holdco s income derives from a related business (Opco) Again, CRA states that, although the excluded shares exception does not apply, another exclusion may apply 33

34 October 2018 APFF Roundtable Q. 9 Excluded shares Question 9(c) Holdco owns passive investments acquired many years ago using dividends received from Opco If Holdco carries on a business which earns income derived from property, the shares held by Mrs. X would be excluded shares, notwithstanding that the capital used in the acquisition of property used in carrying on the business of Holdco was derived from Opco (condition (c) is met) Income of Holdco was not derived, directly or indirectly, from one or more related business but rather derived from the business carried on by Holdco CRA will consider GAAR if transactions are effected so that shares qualify as excluded shares to avoid

35 October 2018 APFF Roundtable Q. 10 Discretionary trust interests and s related business valuation Property referred to in cl. (c)(i)(b) of the related business definition includes: shares of a corporation interest in a partnership interest in a trust (regardless of whether the trust is discretionary or not) Question of whether all or part of the FMV of a property is derived, directly or indirectly from shares is a question of fact The determination of the FMV of an interest in a discretionary trust is a question of valuation 35

36 October 2018 APFF Roundtable Q. 11 Tracing dividends paid by Holdco to stock portfolio rather than related business Kid Parent Holdco P/S C/S Holdco Income: 150 K passive investments 100 K Opco dividend Opco 36

37 October 2018 APFF Roundtable Q. 11 Tracing dividends paid by Holdco to stock portfolio rather than related business Is the dividend from Holdco to Kid subject to TOSI? Holdco must adequately monitor its funds derived from Opco and funds derived from its portfolio in order to determine which funds are used to pay a dividend If funds derive from Opco: Dividend would derive directly or indirectly from a related business If funds derive from portfolio: If Holdco carries on a business: Business would not qualify as a related business there is no source individual who is active in Holdco or has significant ownership of Holdco TOSI does not apply If Holdco does not carry on a business: There is no related business TOSI does not apply 37

38 October 2018 APFF Roundtable Q nonapplication to partnership holding listed shares Family partnership that generates and distributes passive income from stock market investments to Parents and Children Children have not contributed to or been involved in the Partnership, compared to Parents who communicate with broker four times per year Is the partnership income subject to TOSI? There is no split income: dividend income or capital gain received by any of the partners in respect of shares: listed on a designated stock exchange, or of a mutual fund corporation CRA will review the application of various provisions 38

39 October 2018 APFF Roundtable Q. 13 Split income tax and distribution of reinvested capital gain Mr. Mrs. Kid X (minor) Kid Y (22) Holdco Portfolio generated $150,000 passive income. Holdco will pay a $100,000 dividend on a prorata basis (directly to individuals and indirectly via the Trust) 39

40 October 2018 APFF Roundtable Q. 13 Split income tax and distribution of reinvested capital gain Trust sold shares of an Opco and allocated the capital to the family. They each claimed LCGE Parents and Children acquired shares of Holdco using capital from the Trust Holdco used the subscription proceeds to acquire an investment portfolio Holdco pays dividend to its shareholders from the income earned from the portfolio Does TOSI apply to the dividends received by Mr., Mrs., Kid X and Kid Y from Holdco or from a trust distribution? 40

41 October 2018 APFF Roundtable Q. 13 Split income tax and distribution of reinvested capital gain Kid X (minor) TOSI applies Kid Y, Mr. and Mrs. (adults) If Holdco does not carry on a business TOSI does not apply to a dividend received from Holdco or from a trust distribution (non-related business exception) If Holdco does carry on a business Non-related business exception does not apply Kid Y: Safe Harbour Capital Return exception might apply to a dividend received from Holdco or from a trust distribution Mr. and Mrs.: Excluded shares exception might apply to a dividend received from Holdco and Reasonable return exception might apply to a dividend received from a trust distribution 41

42 October 2018 APFF Roundtable (Financial strategies and instruments) Q. 2 Excluded shares and TOSI > CRA comments on Q.7 from the STEP Roundtable as well as example 10 and 12 from the CRA guidelines > Exclusions are applicable not only to entities that carry on an active business but also to entities that carry on a business whose principal purpose is to derive income from property (assuming that there is a sufficient level of activity) > Answer mirrors Q. 9(a) APFF Roundtable > If Holdco carries on a business: the shares of Holdco may qualify as excluded shares > If Holdco does not carry on a business: the shares of Holdco cannot qualify as excluded shares 42

43 October 2018 APFF Roundtable (Financial strategies and instruments) Q. 3 Testamentary trust and TOSI Facts Life insurance proceeds and stock market investments are left to a Testamentary Spousal Trust, whereby the spouse of the deceased is the sole beneficiary and the children are trustees Trust generates passive income (dividends, capital gains and interest on bonds) Question Under different management scenarios, will the passive income distributed to Spouse subject to TOSI? Response Do the different sources of income qualify as split income is it reasonable to consider that it derives directly or indirectly from a related business? Dividends and capital gains: derived from public corporations; therefore, not split income and TOSI does not apply Interest: split income? Derived directly or indirectly from a related business? If so, do any inheritance/ continuity rules apply? 43

44 October 2018 APFF Roundtable (Financial strategies and instruments) Q. 4 Trusts, rental income and TOSI Facts Testamentary spousal trust owns five commercial rental properties, which were previously managed by the deceased Question Under different management scenarios, will the rental income distributed to Spouse subject to TOSI? Response Does the rental income qualify as split income is it reasonable to consider that it derives directly or indirectly from a related business? Does the trust carry on a business? Is a source individual actively involved in the activities of the trust? If so, an inheritance/ continuity rule can apply such that the income would be deemed to be an excluded amount for the Spouse (since the income would have been an excluded amount to the deceased [120.4(1.1)c)(ii)]) 44

45 October 2018 APFF Roundtable (Financial strategies and instruments) Q. 15 TOSI excluded shares and business income CRA confirms that if a corporation does not have business income, its shares cannot qualify as excluded shares (reiterates STEP, Q. 7) 45

46 May 25, E5 Tax on Split Income General comments provided related to the definition of excluded shares and excluded business 46

47 July 6, E5 Tax on split income and preferred beneficiary CRA confirms that the definition of split income includes trust distributions but not preferred beneficiary amount under s. 104(14) 47

48 August 21, E5 Excluded shares 10 % or more Votes & Value Test For the purpose of the vote & value test in para. (b) of the definition of excluded shares, ownership of multiple classes of shares should be considered. 48

49 September 26, E5 Revised income sprinkling rules CRA states that a shareholder-spouse may be exempt from TOSI under the excluded business exception if the spouse does not work for a portion of the year due to birth or adoption of a child sufficient involvement can still be proven even if the 20-hour test is not met. Same may be true in case of illness. CRA does not comment on application of excluded shares exception due to insufficient details. 49

50 November 2, E5 TOSI and the meaning of derived directly or indirectly from a related business Facts Mr. Mrs. Investco Opco Will dividend income be considered to derive directly or indirectly from a related business in the following scenarios: 50

51 November 2, E5 TOSI and the meaning of derived directly or indirectly from a related business 1. If Investco pays all of the dividend income from the publicly traded corporations to Mrs: If Investco does not carry on a business : non-related business exception would apply and, therefore, TOSI would not apply If Investco does carry on a business : non-related business exception would not apply and we would need to determine if another exception could apply. 51

52 November 2, E5 TOSI and the meaning of derived directly or indirectly from a related business 2. If Investco pays a dividend in kind to Mrs and transfers the portfolio to Mrs: Y1 Opco dividend to Investco = $1M and Investco acquires the Portfolio Y2 Holdco pays dividend in kind = $1.1M The portion of the FMV of the portfolio that represents the initial investment of the Opco dividends ($1M) would be considered to be derived, directly or indirectly, from a related business of Opco non-related business exception does not apply If Investco does not carry on a business: The portion of the gains (100K) would not be considered to be derived, directly or indirectly, from a related business of Opco or Investco nonrelated business exception applies If Investco does carry on a business: non-related business exception would not apply and we would need to determine if another exception could apply. 52

53 November 2, E5 TOSI and the meaning of derived directly or indirectly from a related business 3. If all the dividends from Opco to Investco we paid prior to new TOSI (pre-2018), would the answers be different: Conclusions above would not change 53

54 November 2, E5 Meaning of reasonable return Mr. Mrs. Xco Start-up capital: mortgage proceeds loaned by Mr. and Mrs. Loan has now been repaid by Xco to Mr. and Mrs. 54

55 November 2, E5 Meaning of reasonable return Q.1: If Mr. receives a dividend from Xco, would the reasonable return exception apply to him in regards to the risks he initially assumed on the start-up of Xco s business? CRA would consider the fact that both Mr. and Ms. risked their family home by mortgaging it in order to provide the Loan to Xco CRA would also consider if they were both adequately compensated for taking the risk, based on the terms and conditions of the Loan If the terms of the Loan were not sufficient, the relative risk assumed could be taken into account in determining whether a dividend received by Mr. X after the repayment of the Loan is a reasonable return 55

56 November 2, E5 Meaning of reasonable return Q.2: Can Mr. look at the undistributed retained earnings of Xco as capital that is at risk for purposes of this exception? The undistributed retained earnings of Xco do not represent capital contributed directly or indirectly by either of Mr. or Ms. This factor is not relevant in assessing their relative contributions to the related business carried on by Xco 56

57 Conclusion TOSI seems to apply as a general rule, subject to various exceptions The exceptions are not mutually exclusive Income splitting opportunities are limited but not impossible - Depends on the age of the specified individual - Depends on the type of income earned by the specified individual and/or the entity carrying on the business - Depends on type of business and the existence of a business - Depends on the contributions in support of the business - Depends on different stages of life of the specified individual and the entity carrying on the business 57

58 Conclusion Implementing a freeze Remains an important estate planning measure for the freezor Remains an important tool in the integration of future generations and key employees (either through a trust or direct ownership) Trusts Creditor protection benefit remains Family dynamic consideration still relevant Multiplication of LCGE remains The landscape is ever-changing! 58

59 Merci / Thank you! RICHTER KATHERINE BORSELLINO LL.B, J.D., LL.M (FISC.) Manager, Tax T KBorsellino@Richter.ca EMILIE CHAMPAGNE-COUILLARD LL.B, D.E.S.S. (FISC.) Associate, Tax T EChampagne-Couillard@Richter.ca 59