2018-0743961C6 STEP Question 5 - Tax on Split Income

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Various issues relating to the reference to "income" in the proposed amendments to Section 120.4.

Position: General comments provided.

Reasons: Wording, scheme and underlying policy of the proposed amendments to Section 120.4.

Author: Chong, Henry
Section: Section 120.4

2018 STEP CRA Roundtable - May 29, 2018

 
Question 5 - Split Income Proposals
 
In the definition of excluded shares, subparagraph (a)(i) refers to 90% of the “business income,” of a corporation while in paragraph (c), the wording uses “all or substantially all of the income”. We would like to understand what these terms mean within these definitions.  It would seem reasonable that business income is the income of the corporation from a business, and refers to net income.  Since subparagraph (a)(i) requires a determination of whether less than 90% of the corporation’s business income is derived from the provision of services, does this mean that a segmented computation of business income needs to be done, allocating the business income between income from services and income from other sources, such as the sale of goods?  In addition, there is uncertainty with respect to paragraph (c) of the definition of excluded shares and the words, all or substantially all of the income.  Does this refer to net income or something else such as revenue?
 
CRA Response
 
The reference to “business income” in the definition of excluded shares is to the income of the corporation from a business.  This is to be distinguished from the use of “income” in the definition which refers to the income of the corporation from all sources.  Whether the income of a corporation is from a business (or from a source other than a business) will depend on a review of all of the facts and circumstances of each case.  In general, any commercial activity carried on by a corporation (or partnership or trust) should be considered a business.  As a result, the starting point in most cases will be that the income of the corporation is from a business.
 
As well, the references to “business income” and “income” in the definition generally means the gross income of the corporation.
 
Under subparagraph (a)(i) of that definition, one of the requirements that must be met for shares of a corporation to qualify as excluded shares of a specified individual is that less than 90% of the income of the corporation is from the provision of services.
 
Where a corporation has income from the provision of both services and non-services (including a service business that also involves a sale of property such as a business carried on by plumbers, mechanics or other contractors that supply replacement parts or building materials), the income from the provision of services and non-services should be computed separately and the non-service income should generally be taken into account in determining whether shares of a corporation are excluded shares of an individual unless such income can reasonably be considered to be necessary but incidental to the provision of the services (for instance as would be the case in an office cleaning service if it billed separately for the cleaning supplies used).  In determining gross income, payments that can reasonably be considered reimbursements of expenses (including reimbursement for the supply of goods) will be ignored.
 
In general, the safe harbour for excluded shares is intended as a bright line test for situations where amounts received by individuals would otherwise be considered a reasonable return.  In some cases, the requirement of a corporation to compute the income from the provision of services and non-services separately for purposes of determining whether the income of a specified individual is excluded from the tax on split income (“TOSI”) as income from excluded shares may give rise to additional compliance requirements.  In some of these circumstances, consideration can be given to whether it may be better for taxpayers to determine whether the amount is excluded from the TOSI because it is a reasonable return of the individual based on the factors applicable in the circumstances.
 

Henry Chong
2018-074396
 

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