2019-0799901C6 STEP 2019 – Q3 – TOSI and Hours Worked

Principal Issues: Can an individual meet regular, continuous and substantial basis test if they work less than the 20 hour per week minimum bright line test in 120(4)(1.1)?

Position: Yes (facts permitting).

Reasons: Individual is actively engaged in the activities of Opco's business based on the facts and circumstances and work performed.

Author: McPherson, Ryan
Section: 120.4(1), 120.4(1.1)

2019 STEP CRA Roundtable – June 7, 2019

QUESTION 3. TOSI and Hours Worked

A safe harbour for purposes of the Excluded Business definition applies where a person works on average at least 20 hours a week during the part of the year that the business is carried on. If this test is met, then the business is considered an Excluded Business and the TOSI rules do not apply by virtue of the amount being an Excluded Amount.

It is noted that the 20 hour week rule is a safe harbour. Working less than 20 hours per week might still meet the requirement for an Excluded Business, since the wording is general in nature, using the phrase “actively engaged on a regular, continuous and substantial basis in the activities of the business”.

Suppose a business is carried on through a corporation owned by husband and wife. Both husband and wife contribute an equal amount of effort but the business only requires 10 hours of work per week on average, with each spouse contributing 5 hours. In these circumstances, can the business be an Excluded Business?

CRA Response:

One of the safe harbour exclusions from TOSI is for income received by a “specified individual” from an “excluded business”. The definition of excluded business is set out in subsection 120.4(1). In general, a business is an excluded business of a specified individual for a taxation year if the specified individual is actively engaged on a regular, continuous and substantial basis in the activities of the business in either: (a) the relevant taxation year; or (b) any five prior taxation years of the specified individual. Whether an individual has been actively engaged in the activities of a business on a “regular, continuous and substantial basis” in a particular year will depend on the circumstances, including the nature of the individual’s involvement in the business (i.e., the work and energy that the individual devotes to the business) and the nature of the business itself. The more an individual is involved in the management and/or current activities of the business, the more likely it is that the individual will be considered to participate in the business on a regular, continuous and substantial basis.

However, without limiting the generality of the “regular, continuous and substantial basis” test described above, a specified individual will be deemed under paragraph 120.4(1.1)(a) to have been actively engaged on a regular, continuous and substantial basis in the activities of a business in a taxation year of the individual if the individual works in the business at least an average of 20 hours per week during the portion of the year in which the business operates. Paragraph 120.4(1.1)(a) is considered as a “bright line deeming rule” that is intended to eliminate some of the uncertainty inherent in the “excluded business” definition described above.

With respect to the scenario provided in the question, as the husband and wife don’t work in the business at least an average of 20 hours per week during the portion of the year in which the business operates the bright line test in paragraph 120.4(1.1)(a) is not met. Accordingly, the other factors used to determine if the specified individual is actively engaged in the activities of the business must be considered.

In Example 9 in our Guidance on the Application of the Split Income Rules for Adults, we considered a similar scenario to the one posed in this question. In that example, Spouse A and Spouse B were the only shareholders of Opco that carried on a business of developing mobile applications. Spouse A and Spouse B both had other jobs and/or attended university and only worked in the business of Opco on evenings and weekends for less than an average of 20 hours per week. There was no need for other employees or more involvement from either Spouse A and Spouse B to work in Opco’s business. We concluded in that fact situation that the specified individuals could be considered as being actively engaged in the activities of the business of Opco on a regular, continuous and substantial basis.

Therefore, in the above scenario both the husband and wife could be considered to be actively engaged in the activities of the business on a regular, continuous and substantial basis even though the bright line test in paragraph 120.4(1.1)(a) is not met by either individual. It is a question of fact as to whether the husband and wife would be considered to meet the excluded business test for a particular taxation year (or continue to meet such test in any subsequent taxation year) as consideration must be given to the ongoing nature, and labour requirements of the corporation’s business.

Additional guidance on the TOSI Rules can be found on the Canada Revenue Agency (CRA) website at: https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/income-sprinkling/guidance-split-income-rules-adults.html.

Ryan McPherson
2019-079990

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