2018-0743971C6 2018 STEP Q6 – Excluded Shares – Holding Company

Principal Issues: Whether shares of the capital stock of a corporation would qualify as "excluded shares". Does the answer depend on whether the holding corporation has income or not, such as dividend income from a subsidiary which might be a related business?

Position: Generally no.

Reasons: In accordance with the legislation and tax policy.

Author: Lafrenière, Jean
Section: 120.4(1)

STEP CRA Roundtable – May 29, 2018

QUESTION 6.  Split Income – Holding company qualifying as “excluded share”

In general terms, is it possible for shares of a holding company to qualify as “excluded shares”?  Does the answer depend on whether the holding company has income or not, such as dividend income from a subsidiary which might be a related business?

CRA Response

Bill C-74 (footnote 1), which has received Royal Assent, contains legislation to expand the tax on split income (“TOSI”) in section 120.4 of the Act, to include adult individuals in order to restrict the benefits of income sprinkling.  Under the legislation, TOSI will apply to the “split income” of a “specified individual” unless the amount is an “excluded amount”, all as defined in subsection 120.4(1).

To alleviate its compliance burden, the legislation included in Bill C-74 expands the definition of excluded amount to include certain safe harbours from split income.  In general, these safe harbour exclusions provide a bright line test and are intended to act as a proxy for situations that would have otherwise been a reasonable return and do not raise any policy concerns.

Subparagraph (g)(i) of the definition “excluded amount” provides that income from, or a taxable capital gain from the disposition of, “excluded shares” of an individual who has attained the age of 24 before a taxation year is an excluded amount.

“Excluded shares” – defined in subsection 120.4(1) – of a specified individual are shares of the capital stock of a corporation that are owned by the specified individual if: 

(a)   the following conditions are met:

i)    less than 90% of the business income of the corporation for the last taxation year of the corporation that ends at or before that time (or, if no such taxation year exists, for the taxation year of the corporation that includes that time) was from the provision of services, and

ii)   the corporation is not a professional corporation;

(b)   immediately before that time, the specified individual owns shares of the capital stock of the corporation that:

i)    give the holders thereof 10% or more of the votes that could be cast at an annual meeting of the shareholders of the corporation, and

ii)   have a fair market value of 10% or more of the fair market value of all of the issued and outstanding shares of the capital stock of the corporation; and

(c)   all or substantially all of the income of the corporation for the relevant taxation year in subparagraph (a)(i) is income that is not derived, directly or indirectly, from one or more related businesses in respect of the specified individual other than a business of the corporation.

As per the Department of Finance’s explanatory notes: 

“This limitation [in paragraph (c)] is intended to prevent the circumvention of the TOSI rules by splitting services business into services and non-services business.  For example, this would apply to the use of holding companies and so-called “side car” structures (e.g. where property used in a service business is leased to a corporation carrying on the services business by another corporation in which the specified individual has an interest.”

The definition “excluded shares” should generally not include shares of a holding corporation. This is because, in the case of a holding corporation, all or substantially all of the income would be derived from a related business in respect of the individual (other than a business carried on by the holding corporation).  As a result, the shares of a holding corporation held by a specified individual will not be excluded shares of the individual and any income from, or a taxable capital gain from the disposition of, such shares, will not be an excluded amount and will be split income of the individual and subject to the TOSI unless another exclusion applies.

Depending on the circumstances, the income from, or a taxable capital gain from the disposition of, shares of a holding corporation may not be split income if other exclusions apply.  For example, where the income is from a related business that is an excluded business – as defined in subsection 120.4(1) – of the specified individual, the income will be an excluded amount of the specified individual and will not be subject to the TOSI.

The safe harbour exclusions, including the one for excluded shares, are not intended to apply in all circumstances.  Where the safe harbours do not apply in a particular case, the general underlying rationale is that in such circumstances, the most appropriate test for determining whether the income of a specified individual from a related business should be excluded from split income should be based on the general test of whether the amount received is a reasonable return according to the specific factors applicable in the circumstances, including the work performed, the property contributed in support of the business, the risks assumed by the specified individual or a related individual, prior amounts received by them in respect of the business, and any other factor as may be relevant.

Jean Lafrenière
2018-074397

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Bill C-74, An Act to implement certain provisions of the budget tabled in Parliament on February 27, 2018 and other measures.

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