Income Sprinkling – The Revised Proposals

The federal government has quickly made good on its promise to release revised draft legislation with respect to its “income sprinkling” proposals.

The government’s objective in releasing this legislation now is to ensure that it takes effect for 2018 as originally envisioned.

The centerpiece of the proposals is the idea that the Tax on Split Income (“TOSI”) will be applied to adults in addition to minor children. The original proposals were heavily criticized as being extremely complex and unwieldy. The Minister of Finance has reworked the rules and they are now extremely complex and unwieldy; however, they are a bit narrower in scope, offering some more objective exceptions. The Canada Revenue Agency has concurrently published a guide on how they will apply the rules.

Extension of TOSI application to adults
If none of the exceptions applies, TOSI rules will be extended to all taxpayers over the age of 17 with respect to certain income (mainly dividends) from a “related business”. Generally, a business is a related business if an individual who is related to the taxpayer is either actively engaged in the business or owns more than 10 per cent of the equity in the corporation that carries on the business.

Extension of TOSI to capital gains
TOSI will apply to taxable capital gains on dispositions of property where the income from that property would be TOSI.

Now let’s explore the main exceptions to TOSI treatment. As we can see, there are different exceptions available to different age groups:

“Excluded Business” – all adults
There will be no TOSI treatment where an adult individual is “regularly and continuously” working in the business. This is a subjective test, but if the taxpayer can show an average of 20 hours of activity per week, he is deemed to qualify for this exclusion. The exclusion applies if the work qualifies in the year or in any five previous years (not necessarily consecutively).

“Excluded Shares” – 25 or older
The TOSI will not apply to a taxpayer aged 25 or older who directly owns shares representing at least 10 per cent of votes and value of the company. The company must not be a professional corporation or earn more than 90% of its income from the provision of services. As transitional relief, taxpayers have until the end of 2018 to reorganize their corporate shareholdings to fit within these rules.

General reasonableness test – 25 or older
For taxpayers aged 25 or older there is a general “reasonableness” test that could apply to income received. TOSI will not apply to amounts paid if they are reasonable in the circumstances based on a number of factors including work performed, capital contributed or risks assumed in respect of a related business.

General prescribed rate of return – 18-24 years
For taxpayers aged 18-24, there is a general prescribed rate of return test that could apply. That is, TOSI will not apply to an amount equal to a prescribed rate (currently 1%) that would be allowed as a return on capital contributed to the company.

Retirement income splitting
The TOSI will not apply to income received by the spouse of a contributing individual where the contributing individual has reached the age of 65 years.

Capital gains exclusions
The TOSI will not apply to taxable capital gains realized on death, or on the disposition of property to the extent that the gains would otherwise qualify for the enhanced capital gains exemption. This is true regardless of whether the exemption is actually claimed.

Inherited property
The TOSI exemptions will carry over to property inherited by a taxpayer to the extent that the deceased qualified for the exemptions. In other words, the heir will step into the shoes of the deceased for the purposes of the rules.

Year-end planning
The new rules are not in effect for 2017. Accordingly, these next few days may offer the opportunity for one final dividend payment to take advantage of income splitting benefits before they disappear.

2018 planning
In the next year, current corporate structures should be reviewed to determine if the TOSI will apply to future dividends paid. Any reorganization required to fit within the “excluded shares” exemption must be completed before the end of 2018. If shares are currently held through a family trust, consider distributing to the beneficiaries.

For taxpayers who work in the business, time records may be recommended to ensure evidence that they meet the 20-hour per week threshold.

What’s Your Tax Issue? Sale of Estate Assets

The Tax Issue

I am in the midst of settling my mother’s estate and my accountant has told me I have to sell her house within one year or else I’ll have to pay capital gains tax. He is also telling me that all my mother’s possessions such as jewellery, furniture and  and artwork may be subject to tax. I’ve never heard of this. Can you tell me if he is right?

The Answer

OK, the first thing you must know is that generally, upon the death of an individual, she is deemed to have disposed of all her capital property immediately before her death for proceeds equal to fair market value at that time.

First, let’s deal with the house. I’m assuming your mother lived in the house for the full time she owned it and it is eligible for the principal residence exemption. That means there will be no tax on the gain at death, but you will still inherit the place at a tax cost to you equal to the fair market value of the house at the time of her death.

Now the question is, how do you determine what the fair market value was at the time of death? Well the best way is to actually sell the house immediately. The closer the date of the sale to the date of death, the better estimate you have of the value at death. The longer you wait to sell, the more you will have to rely on an estimate of the value at the time of death based on valuation methods. Whatever the difference is between the value at the time of death (i.e., your tax cost) and the actual sale proceeds when you sell will become a capital gain or loss in your hands.

If you feel the value will be going up in the future, then if you plan to sell, do it sooner rather than later if you want to avoid having to report a capital gain on the increase in value from the time of death.

If the value goes down, then selling within the first year of death allows you to make a special election to use the capital loss against any gains reported on your mother’s final tax return.

Now to the other stuff. Technically speaking, all personal belongings are referred to in the law as “personal use property”, and they are subject to special rules. They are also deemed disposed of at the time of death at fair market value. The only difference is that each item has a deemed minimum cost base and minimum value for tax purposes of $1,000. So, any item that is worth less than $1,000 will not be taxed.  Gains will be taxed, and losses, if any, may be applied only against gains from other personal use property.

Items such as jewellery and artwork are another subset of personal use property called “listed personal property”, and are also subject to the above rules. Losses on this type of property, however, can only be applied against gains from other listed personal property.