The Jewish Community Foundation of Montreal Welcomes you to PAC 2019
Welcome Update on Tax on Split Income (TOSI) Isabelle Nadeau, B.C.L., LL.B., LL.M. Fisc. Crowe BGK LLP June 13, 2019
1. Brief summary of the TOSI rules - Fundamentals • The following is a simplified and non-exhaustive overview of the TOSI rules found in section 120.4 of the Income Tax Act. • The new TOSI rules are applicable since January 1, 2018. • TOSI applies when a “specified individual” earns “split income”, unless an exception can be found. • When income is subject to TOSI, it is taxed at the maximum personal tax rate, which effectively eliminates the tax benefits for sprinkling income amongst family members. • A “specified individual” designates any individual who is resident in Canada, except a trust. • In the case of minor children, there is an additional requirement to have a parent resident in Canada.
1. Brief summary of the TOSI rules – “Split income” • The definition of “Split income” includes different types of income: • Taxable dividends received on shares of private corporations, whether earned directly by the “specified individual” or via a trust or partnership • Income allocated by a partnership or trust, if it is derived from: • Rental income, on condition that a family member of the “specified individual” has a sufficient connection with the rental activities; or • A “related business”
1. Brief summary of the TOSI rules – “Split income” (cont’d) • The definition of “Split income” includes different types of income: • Interest earned on debt obligation issued by private corporations • Taxable capital gains realized personally or via a trust on the disposition of: • Shares of private corporations, and • In certain circumstances: • an interest in a partnership or trust • a debt obligation issued a private corporation
1. Brief summary of the TOSI rules – Exceptions • TOSI does not apply to the following types of income: • Exceptions available to all “specified individuals”: • Taxable capital gains realized personally or via a trust on the disposition of “qualified small business corporation shares” • Income or taxable capital gains earned by a “specified individual” whose spouse or common-law partner has reached the age of 64, to the extent that this income/gain would not have been “split income” if it had been earned by the spouse/common-law partner
1. Brief summary of the TOSI rules – Exceptions (cont’d) • TOSI does not apply to the following types of income: • Exceptions available to “specified individuals” aged at least 17: • Income not derived from a “related business” of the “specified individual” • Income derived from an “excluded business” of the “specified individual”
1. Brief summary of the TOSI rules – Exceptions (cont’d) • TOSI does not apply to the following types of income: • Exceptions available to “specified individuals” aged at least 24: • Income that is a “reasonable return” for the contribution in the business made by the “specified individual” considering labour, capital, risks assumed, etc. • Income from (or taxable capital gains from the disposition of) “excluded shares” owned by the “specified individual”.
2. Recent guidance from the CRA on the TOSI rules The CRA has confirmed that the application of the TOSI rules may cause surprising results. Two structures which are economically similar may not attract the same TOSI treatment: Scenario 1 Scenario 2 Source: Technical interpretations 2018-0761601E5 and 2018-0768801C6
2. Recent guidance from the CRA on the TOSI rules (cont’d) The CRA has confirmed that supporting documentation is key in claiming an exception to the TOSI rules. Example: Source: Technical interpretation 2018-0761601E5
3. Selected planning opportunities – A. Structures involving family trusts Are typical estate freezes still relevant? Before the freeze 5 years after the freeze
3. Selected planning opportunities – A. Structures involving family trusts (cont’d) • Are typical estate freezes still relevant? • YES: • A typical estate freeze structure still allows the multiplication of the lifetime capital gains exemption. • A typical estate freeze structure can help reduce taxes payable upon eventual death of the Founder by reducing the value of the assets owned directly by the Founder at the time of death. • However, under the new TOSI rules, this structure no longer allows the splitting of dividends amongst family members who are beneficiaries of the trust and who do not contribute to Opco’s business. Children
3. Selected planning opportunities – A. Structures involving family trusts (cont’d) Modified structure #1: dividend splitting opportunity in certain circumstances
3. Selected planning opportunities – A. Structures involving family trusts (cont’d) Modified structure #2: purification of Opco and potential additional dividend splitting opportunity * Source: technical interpretations 2018-0768801C6; 2018-0771861E5; 2018-0779981C6; 2018-0768821C6
3. Selected planning opportunities – B. Prescribed interest rate loans Loan to low-income family member Loan to trust in which a low-income family member is beneficiary
3. Selected planning opportunities – C. Paying salaries to low-income family members • Salaries received by family members from a corporation are not subject to the TOSI rules. • Like any expense, salaries are subject to a reasonability test. • To be tax deductible by the corporation that pays them, the salaries must be reasonable in regards to the work performed by the employees. • Work done by family members earning a salary should be carefully documented. • In addition to being an effective income splitting strategy in the year in which they are paid, reasonable salaries paid to family members provide other long-term tax benefits by allowing family members to accrue RRSP room.
3. Selected planning opportunities – D. Paying dividends to low-income family members who were previously involved in the business • If a family member was actively engaged in the business carried on by a corporation but has temporarily or permanently ceased to be active in the business, dividends can still be paid to this low-income family member without causing the TOSI rules to apply to the dividend if the family member was actively involved in the business during at least five years in the past. • These years do not need to be consecutive. • The dividends paid to this family member will not be subject to TOSI based on the “excluded business” exception available to “specified individuals” having reached the age of 17. • The non-application of TOSI in this context has been confirmed by the CRA in technical interpretation 2018-0783741E5.
3. Selected planning opportunities – E. Other simple income splitting strategies • Paying to family members dividends from the corporation’s capital dividend account • These dividends are not taxable and therefore they are excluded from the definition of “split income”. The family members can then invest the funds to earn investment income that will be taxed in their hands at the lower tax rates. • TFSA contributions • A high-income individual may contribute to his or her spouse’s TFSA. This allows the spouse to earn tax-free investment income. • Tax attribution rules do not apply to TFSA contributions. • Payment of family expenses • The high-income spouse should consider paying for all family expenses to allow the low-income spouse to retain his or her earnings. This will maximize the capital that low-income spouse can invest to generate investment income that can then be taxed at the lower tax rates.
Isabelle Nadeau, B.C.L., LL.B., LL.M. Fisc. Tax Partner Crowe BGK LLP T: +1 (514) 908 3625 E: firstname.lastname@example.org
Analyzing the New Passive Investment Income Rules & RDTOH Regime Robert Korne LLB/B.C.L., TEP, Spiegel Sohmer Inc. June 13, 2019 (This presentation was part of a larger presentation previously prepared and presented with Steven Moses of PSB Boisjoli S.E.N.C.R.L.- LLP)
Passive Investment Income Why the changes? • Current corporate taxation • A Canadian-controlled private corporation (“CCPC”) earning active business income (“ABI”) can benefit from a “small business deduction” (“SBD”) and taxed at an even lower rate on its first $500,000 of ABI (SBD limit must be shared among a group of associated corporations) • SBD is eliminated gradually as taxable capital within an associated corporate group increases from $10 M to $15 M
Passive Investment Income • Stated objectives of SBD: • To increase the after-tax cash available for CCPCs to reinvest in their business • Recognizes that small businesses may have difficulty accessing capital • Perspective of Finance Department: • “When retained earnings taxed at the small business rate are used for passive investments rather than in the business, significant tax deferral advantages can be realized relative to an individual investor”
Passive Investment Income • 2018 federal budget proposed to: • Reduce the tax rate on active business income eligible for the SBD (10% for 2018 and 9% for 2019) – (from fall 2017) • Reduce the SBD limit for companies within an associated group based on passive income beginning after 2018. • Limit the availability to recover RDTOH when an eligible dividend is paid.
Passive Investment Income • How does it work? • The SBD will be reduced based on an associated group’s annual passive income • Up to $50,000 of prior year’s passive income (“adjusted aggregate investment income” (“A.A.I.I.”)) is acceptable • A.A.I.I. of between $50,000 and $150,000 will reduce access to the SBD • Each $1 of passive income in excess of $50,000 reduces SBD availability by $5
Passive Investment Income • For these purposes, two new definitions were added in s. 125(7): (i) A.A.I.I. and (ii) “active assets” for the purposes of calculating the business limit reduction. • To determine A.A.I.I., start with the “aggregateinvestment income” and modify: • exclude capital gains or losses realized on the disposition of “active assets” • add back net capital losses carried over from another year and foreign taxes paid on foreign accrual property income (“FAPI”) • Include dividends from non-connected corporations (portfolio dividends) and • Include income from a specified investment business and income from savings in a life insurance policy that is not an exempt policy
Passive Investment Income An asset of a CCPC will be an “active asset” if: it is an asset used principally in an active business carried on primarily in Canada by the CCPC or a related CCPC (an “Active Business Property”) it is a share of a corporation with which the CCPC is connected (for the purposes of Part IV) and would meet the definition of a “qualified small business corporation share” in s.110.6(1) if it were held by an individual shareholder (“Active Shares”) or
Passive Investment Income • the asset is an interest in a partnership where • the fair market value of the interest held by the CCPC is at least 10% of the fair market value of all of the partnership interests • throughout the 24 months prior to the disposition date more than 50% of the fmv of the partnership’s property (directly, or through another partnership) was attributable to Active Business Property or Active Shares and • on the disposition date all or substantially all of the fmv of the partnership’s property (directly or through another partnership) was attributable to Active Business Property or Active Shares
Passive Investment Income Daughter-in-law Beneficiaries 100% shares - Father-in-law - Son - Grandchildren (minors) FT Father-in-law DILco 100% freeze voting preferred shares FILco 100% Common shares Active Business Portfolio earns $200,000 of A.A.I.I. Impact on associated companies
Passive Investment Income • Question: Is the SBD of DILco ground down? • Answer: Yes, as DILco and FILco are associated, pursuant to s.256(1)(b) • Why? • s.256(1.2)(f)(ii) deems each beneficiary (including minors) to own all of the common shares owned by FT • s.256(1.3) deems each parent to own shares owned by minors, including those deemed by s.256 (1.2)(f)(ii) • s.256(1.2)(c)(ii) deems control by a person who owns common shares of a corporation with a FMV of more that 50% of the FMV of all issued common shares Therefore, daughter-in-law is deemed to control both companies
Passive Investment IncomeTechnical Interpretation: 2017-0685121E5 (September 14, 2017) • Associated corporations - through third corporation: 256(2) • Aco, Bco and Cco – each owned 100% by a different child; Dco – controlled by taxpayer + non-voting common shares owned by discretionary trust • S.256(2) applies such that Aco, Bco and Cco are associated among selves • Three s.256(2) elections by Dco: Aco, Bco and Cco are not associated for purposes of s.125(1) and Dco’s business limit deemed nil • S.256(2) election now more important • Aco will avoid A.A.I.I. and taxable capital of Bco and Cco; • Aco, Bco and Cco each still associated with Dco • A.A.I.I. and taxable capital of Dco taken into account for Aco’s, Bco’s and Cco’s business limit grind under s.125(5.1)
Passive Investment Income Planning ideas to minimize SBD grind • Corporate-owned life insurance - not A.A.I.I. • contributions in excess of pure cost of insurance and then extract as CDA • policy as collateral for loan • Investments that minimize taxable distributions • Capital gains • Investing in longer-term assets • Timing dispositions – (i) no longer active or (ii) all in same year • Investments in non-associated corporation • Restructure ownership • Caution: s.125(5.2) – anti-avoidance rule. Transfer or loan to a related corporation - one of the purposes is to avoid the new rules - related corporations deemed to be associated for the purpose of A.A.I.I.
Passive Investment Income New RDTOH Regime Before new regime: tax refund by corporation on investment income regardless of whether dividends paid were as eligible or non-eligible. The objective for the changes was to “better align the refund of taxes paid on passive income with the payment of dividends sourced from passive income” (2018 federal budget). For taxation years beginning after 2018, the amount of RDTOH available is limited when eligible dividends are paid (i.e. from income taxed at the general corporate active rate).
Passive Investment Income How does it work? • 30.67% of investment income is included in the RDTOH account • Canadian portfolio dividends: 38.33% Part IV tax and same added to RDTOH • Refund rate: $0.3833 for each $1 of taxable dividends paid • Two RDTOH pools • Exception: eligible refundable dividend tax on hand (“ERDTOH”): • Part IV tax resulting from eligible portfolio dividends; and • connected corporate dividends to the extent of any ERDTOH refund • General rule: non-eligible refundable dividend tax on hand (“NRDTOH”)
Passive Investment Income How does it work? (con’t) • Ordering on how a dividend refund is calculated: • Eligible dividends only enable a refund of the company’s ERDTOH balance • Eligible dividends do NOT enable a refund of NRDTOH • ONLY non-eligible dividends enable a refund of the company’s NRDTOH • Non-eligible dividend may enable a refund of the company’s ERDTOH
Passive Investment Income • ORDERING: how does this work? • S.129(1) provides that the dividend refund will be equal to the total of: • for eligibledividends, an amount equal to the lesser of • 38 1/3% of the total of all eligible dividends paid by it in the year, and • its ERDTOH at the end of the year, and • in respect of taxable dividends (other than eligible dividends), an amount equal to the total of • the lesser of • 38 1/3 % of the total of all taxable dividends (other than eligible dividends) paid by it in the year, and • its NRDTOH at the end of the year, and
Passive Investment Income • either • if the amount determined under (a)(I) exceeds the amount determined under (a)(II), the lesser of • the amount of the excess, and • the amount by which the corporation’s ERDTOH at the end of the year exceeds the amount, if any, determined under subparagraph i. for the year, or • in any other case, nil If 38 1/3% of non-eligible div ˃ NRDTOH balance → access ERDTOH bal.
Passive Investment Income • Example: • ERDTOH balance = $ 50 • NRDTOH balance = $ 200 • Pay non-eligible dividend = $1,000 • Dividend refund equals the following: • in respect to eligible dividends: $0 • in respect of non-eligible dividends: $250 ($200 + $50) Therefore all ERDTOH is refunded on a non-eligible dividend paid
Passive Investment Income Part IV tax refunds will remain available from all the accounts, subject to the s. 129(1)(a) ordering rule. Effect will be that GRIP dividends will only give rise to Part IV tax refunds if there is sufficient ERDTOH Non-eligible dividends will give rise to NRDTOH first and then to ERDTOH Eligible dividends are much less attractive when NRDTOH exists in excess of the ERDTOH balance
Passive Investment Income • THANK YOU VERY MUCH
POTPOURRI presented to PAC 2019 Nancy Cleman LAPOINTE ROSENSTEIN MARCHAND MELANÇON, S.E.N.C.R.L. June 13, 2019
Topics • Bill 86- Amendments to the CBCA to identify individuals with signifigant control –in force June 13, 2019 • Enquiries in Canada and Abroad in the context of a tax audit- what you need to produce for a Requirment • Estate matters- Obligations to file US Estate returns if deceased holds US situs assets in excess of US $60K ; • Digital Assets- developments and tips
From Corporations Canada website • As of June 13, 2019, all Canada Business Corporations Act (CBCA) corporations, except some distributing corporations, will have to create and maintain a new type of register that lists all individuals that have a significant control over the corporation. • The intent of the Individuals with Significant Control (ISC) Register is to provide greater transparency over who owns and controls a corporation, and to help law enforcement agencies expose activities like money laundering and tax evasion.