2019-0799911C6 STEP 2019 Q4 - TOSI & Meaning of Excluded Business

Principal Issues: Whether dividend income earned by a spouse who works as a part-time receptionist in the business would be subject to TOSI.

Position: No.

Reasons: See below.

Author: Ng, Tania
Section: 120.4

2019 STEP CRA Roundtable – June 7, 2019

QUESTION 4.  TOSI and the Meaning of “Excluded Business”

A resident of Canada (“Individual”) carries on a professional practice through a professional corporation (“XCo”).  Individual owns all the voting common shares of XCo and the spouse of Individual (“Spouse”), who is also an adult resident of Canada, owns non-voting preferred shares of XCo.  Spouse acts as a part-time receptionist for XCo and on average, works at least 20 hours per week.  Typically, a part-time receptionist working similar hours would be paid a salary of $18,000 per annum, however, Spouse, by virtue of being a shareholder of XCo, receives a dividend of $150,000 each year.

Can the CRA provide confirmation that the dividend income received by Spouse from XCo on the non-voting preferred shares will not be subject to tax on split income (“TOSI”)?  Specifically, can the CRA confirm that the dividend income received by Spouse will be considered an “excluded amount” pursuant to subparagraph (e)(ii) of that definition found in subsection 120.4(1) of the Income Tax Act (Canada) (the “Act”) by virtue of the fact that paragraph (a) of the “excluded business” exception will apply because Spouse works at least 20 hours a week as a part-time receptionist for XCo?

CRA Response

In the situation described above, Spouse is a “specified individual” as defined in subsection 120.4(1) and Individual is a “source individual” (also as defined in subsection 120.4(1)) in respect of Spouse.  The business carried on by XCo is a “related business” in respect of Spouse for the relevant taxation year (see subparagraph (a)(ii) and paragraph (c) of the definition of “related business” in subsection 120.4(1)).

As such, if Spouse receives dividends on the non-voting preferred shares of XCo in a particular taxation year, such dividends will be “split income” unless it is an “excluded amount”.  Pursuant to subparagraph (e)(ii) of the definition of “excluded amount” in subsection 120.4(1), such dividends could be an excluded amount if such amount is derived directly or indirectly from an “excluded business” of the individual for the year.  The term “excluded business” is also defined in subsection 120.4(1) and generally includes a business in which the specified individual is actively engaged on a regular, continuous and substantial basis in the year (see paragraph (a) of the definition of “excluded business”).

It is a question of fact as to whether an individual is “actively engaged on a regular, continuous and substantial basis”.  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 and the nature of the business itself.  Whether an individual is actively engaged in a business will generally turn on the time, energy and work the individual devotes to the business.  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.  Likewise, the more an individual’s contributions are integral to the success of the business, the more substantial they would be.

However, without limiting the generality of the “regular, continuous and substantial” test described above, paragraph 120.4(1.1)(a) will deem a specified individual to be actively engaged on a regular, continuous and substantial basis in the activities of a particular business for a particular year if that individual works an average of 20 hours per week of work throughout the portion of the year when the business operates.

Assuming Spouse works for XCo on average at least 20 hours a week throughout the portion of the year when that business operates, the bright-line test in paragraph 120.4(1.1)(a) is met.  As such, the dividend income received by Spouse would be considered an “excluded amount” because the exception in subparagraph (e)(ii) of that definition in subsection 120.4(1) for an amount derived from an excluded business is met. Accordingly, the dividend income received by Spouse would not be subject to TOSI.

Tania Ng
2019-079991

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