July 3, 2023

2018 TOSI Changes: Highlights for Small Business Owners

Not only did January 1 usher in the new year, it also brought about a major change in Canada’s tax law, which is especially impactful for small business owners. The government released new tax requirements for split income received from private corporations.

Income splitting has traditionally allowed entrepreneurs to include family members as part of the corporation’s ownership structure. Through utilizing either share holdings or family trusts, dividends can be paid out to different family members, typically in lower tax brackets. The result is a lower tax burden for the family.

What was the existing TOSI rule?

Prior to 2018, the Tax on Income Splitting (TOSI) created a tax at the highest marginal rate on minors under 18 who received income from private corporations owned by family members.

Income subject to TOSI includes (among other things) private corporation dividends and capital gains.

Small business owners can still expect to pay this premium tax rate if splitting income to minors in this way.

What has changed with TOSI?

While the TOSI rules for minors haven’t changed in 2018, the rule has been extended to include certain income received by individuals over the age of 18 as well. There are, however, multiple exclusions to the new TOSI rules. Here are the most common ones that small business owners may qualify for.

Exclusions for Adults between 18 and 24 Years Old

Adults who are between the age of 18 and 24 may exempt income from TOSI that is from an excluded business, which applies if the individual was actively engaged in the business. To qualify, the person must have worked for a minimum of 20 hours per week on average. This can take place either during the tax year, or during any of the five previous tax years. Additionally, work completed in the previous years doesn’t have to be consecutive.

Additional exclusion allows these adults to omit a return that is less than or equal to the current prescribed capital return rate, currently at 1%.

Alternatively, the individual can exclude a reasonable return on capital contributions that are made with arm’s length capital. This includes property that uses a loan or was transferred from a related person, but not through an inheritance.

Adults Over 24 Years Old

In addition to the above exclusions, individuals in this age bracket also have the ability to exclude capital gains from excluded shares or any payments considered a reasonable return.

Excluded shares from a private corporation include shares that give both 10% of votes and value. These shares cannot, however, come from a professional corporation or a services business.

Individuals over 24 can also exclude reasonable returns, which are based on various factors such as labour contribution, property contribution, risk incurred, and historic payments.

Retired Spouses and Common-Law Partners

The final TOSI exemption is aimed at helping spouses and common-law partners in retirement. The new TOSI rules won’t apply to private company dividends or capital gains paid to an owner’s spouse or partner if he or she “meaningfully contributed to the business” and is at least 65 years old.

What do these changes mean for small businesses?

The new rules apply to the 2018 taxation year, so small businesses should start preparing now. To allow businesses to calculate their TOSI using the new rules, the Canada Revenue Agency will issue an updated Form T1206.

Corporations have until the end of 2018 to restructure to meet the excluded shared definition, which will then apply the exclusion to the entire year. Additionally, TOSI will not apply to arm’s length sales of QSBC shares that qualify for the lifetime capital gains exemption.

The CRA also suggests keeping timesheets, schedules, or logbooks in order to have the proper documentation for the 20-hour exclusion.

For a more comprehensive discussion on how the new rules impact you, please contact us.

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