On June 21, 2018 Bill C-74, An Act to implement certain provisions of the budget tabled in Parliament on February 27, 2018 and other measures (“Bill C-74“) received Royal Assent. Bill C‑74 includes various amendments to the Income Tax Act (Canada) (the “Act“), including amendments to section 120.4, formerly known colloquially as “kiddie tax” and now referred to as tax on split income (“TOSI“). These changes were first proposed in July 2017.

As Bill C-74 was being debated in the House of Commons and the Senate, practitioners gathered for the annual meeting of the Conference for Advanced Life Underwriting (“CALU“) and the Society of Trust and Estate Practitioners (Canada) National Conference (“STEP“).

This is the fourth article in a series of articles discussing the TOSI rules. Part I discussed the types of income that TOSI applies to and some of the exceptions. Part II discussed the remaining exceptions to the general rule. Part III focused on clarifications to the “excluded shares” exception first introduced in Bill C-74 and discussed the use of family trusts in this new TOSI landscape. This article highlights comments from the Canada Revenue Agency (“CRA“) and Department of Finance (“Finance“) made at the roundtable at CALU and STEP.

Conference for Advanced Life Underwriting

CALU was held on May 6 to 9, 2018 in Ottawa. The conference hosted a CRA and Finance Roundtable where senior representatives responded to general and specific questions posed by members.

Excluded shares and provision of services

One of the exceptions to TOSI is the “excluded shares” exception. One of the conditions that must be satisfied for the “excluded shares” exception to apply is that less than 90% of the business income of the corporation be from the provision of services (the “Services Test“). Unfortunately, “services” is not defined in the Act. The interpretation of this condition is a major concern for tax professionals and business owners.

The CRA was asked to provide guidance on its interpretation of the Services Test. The CRA commented that whether 90% or more of the business income of the corporation was from the provision of services would be a question of fact having regard to all the circumstances and that the interpretation of this provision will develop over time. The CRA also suggested that they will be publishing additional commentary soon. It may be several years before a dispute over the interpretation of the phrase “provision of services” finds its way to the Tax Court, particularly given that many tax disputes are not pursued given the dollar amount at issue or are settled before trial. Until a strong body of law is established, we will have to rely on CRA guidance and the taxpayer’s own interpretation.

It is understood that the expansion of the TOSI rules is meant to capture income received by non-active family members from professional corporations. However, the “excluded shares” exception will also not apply to a significant number of other types of corporations in the service sector in addition to professional corporations. According to Statistics Canada, at the end of 2015, over 75% of small businesses were categorized as being in the service producing sector, such as financial services, retail trade, healthcare, and scientific and technical services. Finance was asked to explain the policy for including this Services Test given the large number of Canadian businesses engaged in the services industry.

Finance commented that the “bright line” exceptions included in Bill C-74 (including the “excluded shares” exception) were added to provide some flexibility and to clarify the exceptions to TOSI that were first introduced in July 18, 2017, being that the individual receive a reasonable return having regard to their labour contribution, capital contributed to the business, and risk assumed in respect of the business. Finance identified that businesses that earn income substantially from the provision of services are at the highest risk of splitting income with family members that did not contribute any labour or capital, or assume any risk in relation to the business. They also commented that the services exclusion was intended to restrict planning by professional corporations to earn non-professional income in a side business that was not carried on by a professional corporation.

Excluded shares & shares of holding corporations

Another condition that must be satisfied for the “excluded shares” exception to apply is that all or substantially all of the income of the corporation is not derived, directly or indirectly, from one or more related business (the “Related Income Test“). This limitation was intended to prevent “side car” structures, where property is leased by a non-service corporation to a services corporation in which the individual has an interest. However, this condition also captures a corporate structure that involves a holding corporation and a wholly-owned operating corporation.

The CRA was asked to advise whether the shares of a holding corporation could qualify as “excluded shares” given the Related Income Test. In short, the answer was no. The CRA advised that the “excluded shares” exception was not intended to apply to shares of a holding corporation. As raised by many practitioners, there are many non-tax purposes for including a holding corporation in a corporate structure, such as creditor proofing. In a tax system that is supposed to be neutral such that decisions are made for business reasons (not tax reasons), this position is disappointing.

TOSI on income that would otherwise be taxed at top rates

Finance was asked why the deeming rule for high income earners that was in the draft legislation originally released on July 18, 2017 was not preserved in Bill C-74. Initially, the draft legislation contained a provision that deemed an individual’s “split income” to be nil if income from other sources was greater than the income level where the highest federal individual marginal tax rate for the year becomes applicable. According to the Technical Notes released at the time, it was not necessary to apply the TOSI rules to split income that, without the rules, would be taxed at the highest marginal income tax rate. This is logical. TOSI is an anti-avoidance rule. If income from a related business would be taxed at the highest marginal income tax rate in any event, no taxes are being avoided by applying TOSI. However, Bill C-74 did not preserve this provision.

While it may seem like a distinction without a difference, that may not be the case where the taxpayer can claim a tax credit, such as a donation tax credit. Under the TOSI provisions, a taxpayer generally cannot use tax credits to reduce TOSI income. The only credits that are available are the dividend tax credit, disability tax credit, and foreign tax credit.

A scenario was presented where an individual resident in Ontario earned $250,000 of income from employment and received a $100,000 dividend from a related business which was not an excluded amount. Further, he made a $275,000 charitable donation. The dividend would not be subject to TOSI under the draft legislation released on July 18, 2017 but would be subject to TOSI based on Bill C-74. This distinction affects the individual’s charitable donation limit and ability to claim the donation tax credit .

Finance was asked whether they would be agreeable to amending the TOSI rules to deem split income nil in this circumstance. The answer was not encouraging. The response by Finance was that Bill C-74 was already in the House of Commons and that there is no appetite to make further changes at this time.

Although TOSI is a provision intended to restrict splitting income with family members that would otherwise be taxed at a lower rate, TOSI may also negatively impact family members that are high income earners.

Society of Trust and Estate Practitioners (Canada) National Conference

STEP was held on May 28 and 29, 2018 in Toronto. Several questions regarding the “excluded shares” exception were posed during the CRA Roundtable portion of the conference.

First, clarifications with respect to the many new and amended definitions were discussed. It was commented that, in general, all individuals that receive income from a related business are subject to TOSI unless one of the narrow exceptions apply.

The “excluded shares” exception refers to “income” in both the Services Test and Related Income Test, both described above. There has been some discussion between tax professionals about whether the reference to “income” refers to gross income or net income. The CRA clarified their position that the reference to “income” in the definition of “excluded shares” refers to gross income, rather than net income.

The use of holding corporations in the context of the “excluded shares” exception was raised. The CRA reiterated comments made at CALU: generally shares of a holding corporation will not satisfy the conditions in the definition of “excluded shares”.

Finally, the CRA was asked to comment on a situation where a corporation has no business income because it derives income solely from property, such as rental income from real property where the activities are not sufficient to constitute business income. The CRA said that the shares of such corporation could not be considered “excluded shares” because, the way the provision is drafted, the corporation must have some business income. This answer was limited to this particular fact situation.


The above comments are based on attendance at the Roundtables during CALU and STEP and a review of the recently published answers from the CRA.

From the comments made by the CRA and Finance at these Roundtables, it appears that the possible application of the TOSI rules will depend heavily on the reasonableness of the income received from a related business. While the so-called “bright line” exceptions may be useful in certain limited circumstances, there will be many situations where no such exception applies. This results in significant uncertainty for the taxpayer, who bears the burden of proof that the amount received from a related business was reasonable and that TOSI should not apply.

While there is still a lot of confusion about the interpretation and application of some of the TOSI rules, we are slowly getting some guidance from the CRA and Finance, although their comments largely restrict the availability of certain exceptions.

The TOSI rules are effective as of January 1, 2018. However, corporations have until the end of 2018 to complete corporate reorganizations to meet the votes and value test in the “excluded shares” exception if that exception is otherwise available to be used. We suggest that taxpayers carefully review whether this exception may be applicable in their circumstances.