Currently, the “Kiddie Tax” rules provide that dividends received by
persons under the age of 18 from related private companies and income from
related partnerships (whether directly or through a trust) would be taxed
at the top marginal rate. These rules, under the new proposals, have been
substantially extended to apply to all related persons (and not just
minors) where such persons receive income from a related private
corporation, unless the amount is reasonable in light of the circumstances,
having regard to certain criteria. Essentially, spouses, siblings,
parents-in-law, and extended family members can be caught under the new
rules and would have to pay tax at the top rates.
This Tax on Split Income (TOSI) is expanded to apply not only to dividend
income, but also to include interest on loans, taxable capital gains, if
the income on the shares would have been split income, as well as
second-generation income if it is earned on income that was itself split
income (so it’s a compounded effect).
I noted earlier that there is a “reasonableness test.” Essentially, in
order for income not to be subject to this top tax rate, the income must be
reasonable, i.e., it cannot be more than what would be paid to an
arm’s-length person for the same activities provided to the company.
Factors to consider include actual work performed, the capital contributed
for the shares issued to such persons, risk assumed by them, and
compensation for services already completed. Note that the test is more
stringent for persons between the ages of 18 and 24.
The short answer is that if a family member did not contribute money to the
company or is not involved in the company’s operations, then any dividend
income paid to them will be subject to the top marginal tax rates. This
will eliminate the ability to income split with any family member who is
not involved in the business.
There is a specific exemption for minors and adult children who have income
due to the death of a parent, or for persons that are disabled or attending
full time school.
Capital gains exemption
Currently, every Canadian resident (regardless of age) is able to claim the
lifetime capital gains exemption on the sale of shares of a qualifying
private corporation (which gives you the first $800,000 – as indexed –
tax-free). There are three proposed changes to these rules:
Persons under the age of 18 are no longer able to claim the capital gains
exemption. Specifically, any gains accrued before the person turns 18 will
not be eligible for the exemption. So, even if a person is 19 years old,
and the value of his or her shares accrued while such person was a minor,
they could not claim the exemption.
As a continuation of the tax on split income discussed above, if any amount
of a taxable capital gain is included in split income, it will not be
eligible for the capital gains exemption. So, if a family member is not
involved in the company’s business, then arguably the exemption is not
Any capital gains accrued during the time that shares were held by a trust
will no longer be eligible. This is a big change and will affect many
family corporate structures where estate freezes were put in place with
These new rules will come into effect in 2018; however, there is some
transitional relief. If you file an election on your personal tax return by
the due date for 2018, you can take steps to crystallize the capital gain
and claim the capital gains exemption before the end of 2018. This will
bump up your cost base by the capital gains exemption amount, so any future
sale will benefit from a reduced capital gains tax.
Capital gains within a corporate group
New measures were announced to eliminate the ability to pull out cash from
a corporate group by way of a capital gain triggered within the corporate
structure, rather than paying a dividend and being subject to a divided tax
(which is a higher rate than capital gains).
Essentially, the current section 84.1 of the Income Tax Act (which
re-characterizes capital gains as deemed dividends) will be expanded under
the new proposals to deny the ability to trigger a capital gain at the
corporate level and pay out a tax-free capital dividend to the
shareholders. The new rules also include an anti-avoidance rule to deal
with surplus stripping transactions through the use of capital gains to
apply to situations that might not be captured by the newly expanded s.
84.1. Unlike the proposals for TOSI and the capital gains exemption, these
new rules are to apply as of July 18, 2017.
Accumulating funds in Private Corporations
One of the government’s goals was to prevent the use of tax deferrals
through the use of corporations, specifically on income derived from
passive investments held in a corporation. Although the new proposals do
not include actual legislation (like the first three proposals discussed
above), the government outlined, at a very high level, certain options
aimed at reducing the ability to defer tax on such types of incomes. These
Investment income earned by a corporation will be taxed at the highest
personal federal tax rate (33%) with the elimination of the refundable tax
Capital gains on such income will still be subject to 50% tax; however, the
tax-free portion on such capital gains can no longer be paid out tax-free
to an individual shareholder.
Dividends taxed to individual shareholders will be based on the source of
the funds (i.e., whether income was taxed at the small business rate or at
the general corporate rate).
Keep in mind that the government did not announce any draft legislation
regarding the passive income tax proposals, so we are still unsure as to
what they are actually proposing or how they are going to go about it. All
we know is that they are focusing on ways to reduce the ability for
retained earnings that are reinvested to take advantage of the lower
corporate tax rates. The government has announced a consultation period,
and as I mentioned the Minister of Finance is facing the wrath of small
business owners everywhere on his cross-country “consultation.” Whether
this will change anything or not remains to be seen.
For now, be proactive. If you are a shareholder in a private corporation,
and/or your family members are also shareholders, then I would
suggest you speak to your tax advisors to understand how these rules will
affect you and what you may be able to do to minimize the effects.
Samantha Prasad, LL.B. is a Partner with Toronto law firm
Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate,
estate, and international tax planning. She writes frequently on tax
issues, and is the co-editor of various
Wolters Kluwer Ltd. tax publications. This article first appeared in The TaxLetter, © 2017 by
MPL Communications Ltd. Used with permission.
© 2017 by Fund Library. All rights reserved. Reproduction in whole or in
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The foregoing is for general information purposes only and is the opinion
of the writer. This information is not intended to provide specific
personalized advice including, without limitation, investment, financial,
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