CRA Clarifies Interpretation of Tax on Split Income
Canada Revenue Agency recently addressed some specific situations regarding its administration of tax on split income (TOSI).
In October 2019, two CRA comments related to TOSI were issued at the APFF Roundtable in Montreal, and published as Tax Interpretations.
TOSI and temporary leave from a business
The first comment was in response to a question [APFF Roundtable Question # 18] that involved a specified individual who holds only five per cent of the shares of a company (Aco) run by her husband. She has been “actively engaged on a regular, continuous and substantial basis” with that business from 2017 to 2019. Therefore, the CRA said, the dividends she receives on her Aco shares over those three years are excluded amounts that are not subject to TOSI.
CRA was asked if that specified individual was to be absent from work throughout 2020 because of a maternity leave, or as a result of suffering a temporary or permanent disability, whether her dividends would still be considered excluded amounts.
The Agency stated that under such circumstances, the TOSI-excluded business exception would not be available in 2020 because the specified individual would have had no involvement in the business in that year.
Further, the relief under 120.4(1.1) (b)(ii) of the excluded business definition would not be available as the taxpayer was not actively engaged on a regular, continuous and substantial basis in any five prior taxation years, as she would only have been involved in the business for a total of three prior taxation years.
CRA stated, however, that a reasonable return exception with respect to TOSI might be available, noting that any application of this exclusion would be “based on the specific criteria applicable in the circumstances, including the work performed, the property contributed, the risks assumed, the total amounts paid or payable and such other factors as may be relevant.” This may be a tough test to get into, though, as a result of the lack of clarity and guidance from the CRA.
TOSI interaction with corporate attribution
The second comment in October – [addressing APFF Roundtable Question # 16] rejected a proposition that the allocation of income, subject to TOSI, to a specified individual (who is also a designated person) defeats the main purpose test in section 74.4(2) of the Income Tax Act covering transfers and loans to corporations (commonly known as corporate attribution).
CRA noted that the part of the purpose test “related to the designated person only turns on the question of whether it is reasonable to consider that one of the main purposes of the transfer made by the individual was to benefit, either directly or indirectly, the designated person, regardless of the tax treatment to the designated person of any income that is part of the benefit the individual was seeking to confer.”
The Agency said that subsection 74.4(2)(g) was intended to address the potential overlap between section 74.4 and TOSI rules, by providing a narrow scope and application to mitigate the impact resulting from the application of subsection 74.4(2) on the transferring individual. It does so by reducing the amount that individual is deemed to have received as interest for the purposes of the corporate attribution rules.
For example, assume that the outstanding amount of the transferred property is $10,000,000 and the prescribed rate is 2%. The imputed interest on the outstanding amount would be $200,000, which would be included on the transferor’s personal tax return.
Further assume that a dividend in the amount of $1
50,000 (the grossed-up amount) was included in the designated person’s income (who is also a specified individual for the purposes of the TOSI rules).
This dividend would be taxed under the TOSI rules at the highest marginal rate in the hands of the specified/designated person. However, the imputed interest included in the transferor’s income would be $50,000 ($200,000 – Imputed interest less $150,000) equals the TOSI income inclusion as a result of the reduction under 74.4(2)(g) of the Act.
In conclusion, this effectively avoids double tax on the TOSI Income and the corporate attribution imputed interest.