Practical Strategies to Deal with the Impracticalities of TOSI

By By Robyn Campbell, CPA, CA; Published in CPABC in Focus
Published: 03/01/2019

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“TOSI” became the new four-letter word for public practitioners back in July 2017, when the federal government released a consultation paper proposing new rules for the tax on split income (TOSI). The rules have evolved since that summer, and the confusion has only grown.

To the uninitiated, TOSI may seem simple: “There shall be added to a specified individual’s tax payable under this Part for a taxation year the highest individual percentage for the year multiplied by the individual’s split income for the year.” The amount is reduced only by the dividend tax credit and the foreign tax credit on that income, and no other personal credits are permitted. There is complexity, however, and it stems from the definitions of “specified individual,” “split income,” and the exclusions. It is beyond the scope of this article to define these terms and exclusions, but every practitioner needs to learn and understand the new TOSI world and these definitions in particular.

What hasn’t changed: TOSI applies, with few exceptions, to income and taxable capital gains from the disposition of non-public corporation shares to a non-arm’s length person. Double the amount of this taxable capital gain will be included in income and re-characterized as a non-eligible dividend and taxed at the highest individual tax rate. What has changed: Whereas TOSI used to apply only to individuals under the age of 18, the new rules may be applied to individuals of all ages.

For those younger than 18, the implication of receiving split income is still straightforward (but undesirable): TOSI applies. Also straightforward is the test for individuals with a spouse over the age of 65: TOSI will not apply to the income of these individuals if the income would not have been subject to TOSI had it been taxed in the hands of the spouse. For everyone else, it’s best to assume that the TOSI rules apply and then determine whether a strategy is available to deal with their application. And therein lies the complexity.

Below, I outline some practical strategies to address the impractical issues the new rules seem to be causing. Note, however, that the Canada Revenue Agency (CRA) has not yet offered guidance on these strategies, and the wording of the Income Tax Act creates uncertainty. Only time will tell if these ideas are feasible. Therefore, readers are cautioned that there are risks associated with the strategies discussed below.

Excluded business test

The first strategy to deal with the TOSI rules is through the excluded business test. For the amount received to meet the excluded business definition, the individual (aged 18 or over) needs to be “actively engaged on a regular, continuous and substantial basis in the activities of the business in either (a) the taxation year … or (b) any five prior taxation years.” Unfortunately, these terms are not defined and the requirements may differ based on the individual’s age.

Let’s say a family member sits on the board of directors of a company and receives a dividend in lieu of director’s fees. Some suggested ways to meet the exclusion test would be to give the individual an official job title, provide them with business cards, have them submit timesheets, and ensure that the meeting minutes indicate the individual’s involvement/presence and list the topics discussed.

The risk, of course, is that the CRA may not agree the excluded business test has been met, in which case, the income will be subject to TOSI and taxed at the top rate.

Excluded shares test

The second strategy is through the excluded shares test. In over-simplified terms, TOSI will not apply if:

  • At least 10% of the shares of the company, based on votes and value, are held by the individual;
  • The business income is not derived from the provision of services or from a related business; and
  • The corporation is not a professional corporation.

There are several issues with this test. The shares must be held directly by the individual (aged 25 or over). The shares cannot be held by a trust or holding company. If the shares were originally held by a trust or holding company, they would have to have been transferred to the individual directly. And even if they were transferred directly, holding these shares personally may not be a good idea from a non-tax perspective—the shares may have been held by a trust or holding company for any number of reasons, such as creditor proofing or probate planning. Further, transferring the shares to the individual may be a taxable event.

For the excluded shares test to be met, it is critical that “less than 90% of the business income of the corporation for the last taxation year of the corporation … was from the provision of services.” However, the term “provision of services” is not defined … anywhere. Normally, we would look to CRA Views documents or court cases to find the definition, but at the time of this writing, there are only limited CRA Views documents and no court cases to which we can refer. What to do? According to Statistics Canada, over 75% of small businesses provide services, so unless your client’s small business is in the lucky 25%, it seems the excluded shares test may not be met. Meaning—you guessed it—the income is subject to TOSI.

Another way to try and meet the excluded shares test is to alter the legal form of the business but not its substance. As mentioned above, TOSI will apply if more than 90% of the corporation’s business income is from the provision of services. To put this another way, at least 10% of the business income needs to come from the sale of goods. Is it feasible to change the legal form of the business to meet this percentage? Instead of just providing a service, can the business offer the same service by using its own product? For example, instead of providing upholstery services to furniture sellers, can the business be altered to purchase the raw materials, apply the upholstery services, and then sell the finished product? This may not be feasible, and it certainly seems to be the TOSI tail wagging the dog, but it is something to consider.

Treading carefully

We can expect clients to ask us whether TOSI applies to them. We can also expect and understand their frustration when we can’t provide quick and easy answers. As the TOSI rules are complex and contain many undefined terms, public practitioners will need to research each situation carefully before providing any guidance. The only quick answer is that TOSI will likely apply, and the highest individual percentage should be applied to any split income. Admittedly, this feels like defeat, not planning. This is where we currently find ourselves in the new TOSI world.


Robyn Campbell, Senior Tax ManagerRobyn Campbell is a senior tax manager at Smythe LLP in Vancouver, where she specializes in providing tax compliance and advisory services to owner-managed clients.

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