Koroll & Company Blog

In the past, parents who owned or operated corporations would have their minor children, directly or indirectly, subscribe to shares or invest in partnerships, which provided management services to the parent’s company.

They would then declare dividends on these shares, which would be tax-free, as these minors had lower income.

Most often, this income would be held in trust for the child.

The trust would then be used to pay for the child’s expenses – school, camp, extra curriculars.

This process became known as income sprinkling.

To stop taxpayers from benefiting unfairly from income sprinkling, the government introduced a 33% tax on all income split with eligible minor children.

Known as the Kiddie Tax or Tax on Income Splitting (TOSI), this tax was applied to the following:

1. Taxable dividends received from unlisted corporate owned directly or through a trust or partnership
2. Taxable benefits awarded in respect to unlisted shares
3. Partnership or trust income sourced to a relative’s business, either directly or through corporate structure
4. Capital gains on the sale of shares to non-arm’s length individuals, where dividends would be subject to tax
5. Trust income “earned” for services to arm’s length parties where a relative is involved in providing those services
6. Partnership income for services provided to an arm’s length party where a relative has partnership interest

While this change affected a very specific set of tax payers, proposed changes could increase the number of affected companies and individuals going forward.  

This is because, it is now proposed that the income sprinkling rules should be expanded to include spouses and adult children, if the amount received surpasses what is deemed reasonable as per a reasonableness test.

It is also proposed that the tax should be applied to debt interest, gains on disposition of property and second generation income, in addition to incomes listed above.

There are some exceptions in which the TOSI would not apply to adult relatives. These include those who:

1. worked in the business on a regular, continuous and substantial basis in the current year or any 5 previous non-consecutive years
2. are 25 or older and own at least 10% of voting shares and corporation value so long as:
   1. Less than 90% of income is derived from services
   2. It is not a professional corporation
   3. A substantial amount of income is not from a related business
3. are the spouse of someone 65 or older who has made significant contribution to the company
4. inherit shares for which TOSI rules did not apply
5. dispose of property (i.e. shares) that qualifies for the lifetime capital gains exception, whether or not you actually claim the exception

For more information about changes to the income splitting rules and how they could affect your tax planning strategy, contact us today. We look forward to helping you optimize your after-tax position.