2020-0839581E5 TOSI - "Excluded Shares"

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: Clarification of our comments in Technical Interpretation 2019-081943 in respect of paragraph (c) of the definition of "excluded shares" found in subsection 120.4(1).

Position: See below.

Reasons: See below.

Author: Ng, Tania

Section: 120.4

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                                                                                                         T. Ng
                                                                                                         (416) 512-4013
April 8, 2020


Re: Request for Technical Interpretation – Tax on Split Income (“TOSI”)

We are writing to provide clarification regarding technical interpretation 2019-081943 dated January 10, 2020, wherein we provided our comments with respect to the interpretation of the “excluded shares” definition found in subsection 120.4(1) of the Income Tax Act (Canada) (the “Act”) based on the hypothetical fact scenario outlined therein.

Technical Interpretation 2019-081943

The facts set out in that technical interpretation are not replicated in their entirety in this letter, but can be briefly summarized as follows: the scenario involved a corporation (PC1) that carried on a medical services business that also earned income from holding a significant portfolio of investments that were acquired using the earnings of PC1’s medical services business.  Dr. A owned all the voting shares of PC1 while Dr. A and Dr. A’s spouse (Spouse A) each owned 50% of the non-voting shares of PC1.  On December 30 of Year 1, PC1 ceased carrying on its medical services business and on December 31 of Year 1, Spouse A acquired 50% of Dr. A’s voting shares of PC1 for their fair market value.  On January 1 of Year 2, Dr. A incorporated PC2 which carried on the medical services business formerly carried on by PC1.  PC2 does not contribute any capital towards the investment activities in PC1 in Year 2 and subsequent years.

In our technical interpretation, we provided our views on whether the shares of PC1 held by Spouse A would qualify as “excluded shares” for Years 1, 2, 3 and subsequent years.  In respect of Years 1 and 2, no clarification is required.  However, our comments on the application of the “excluded share” definition as it may apply for Year 3 and subsequent years do require clarification since in respect of those years, the CRA’s published comments on “second generation” income as set out in 2018-077998 and 2018-076880 should have been specifically addressed.

Clarification for Year 3 and Subsequent Years

In our technical interpretation, with respect to Year 3 and subsequent years, we had expressed the view that the shares of PC1 held by Spouse A would not qualify as “excluded shares” (and thus dividends paid on such shares to Spouse A would be subject to TOSI), in part, because “…any dividend paid by PC1 to Spouse A would be considered to be derived directly or indirectly from a “related business” carried on by PC2 (and not PC1) in Year 2 and subsequent years”.  We would like to clarify the comment made above which was made in relation to paragraph (c) of the definition of “excluded shares”.

In the event that the income of PC1 for Year 2 and any subsequent year is income earned solely from its investment business, such income would not be considered to be derived directly or indirectly from the medical services business now carried on by PC2.  This would be the case even though the historical retained earnings of PC1 that are used in PC1’s investment business were originally derived from its former medical services business.  Accordingly, in those circumstances, we would consider all the conditions of the “excluded share” definition to be technically met for those years.

Notwithstanding the above, it remains a question of fact as to whether all or substantially all of the income of PC1 would be derived directly or indirectly from a related business other than a business of PC1.  We were not provided with any information with respect to how the medical services business carried on by PC1, including any related assets and liabilities, were transferred to PC2 and it remains to be determined whether PC1 would continue to derive any income from PC2 following the transfer of PC1’s business to PC2 (for example, in the form of service fees, interest income, dividends or rental income), in the context of establishing whether the conditions set out in paragraph (c) of the definition of “excluded shares” are met.

Finally, as noted in our previous technical interpretation, the situation described therein appeared to be undertaken primarily to ensure that the shares of PC1 held by Spouse A would meet the definition of “excluded shares” such that the “excluded amount” exemption would be available to Spouse A.  If it is determined that any transaction, either alone or as part of a series, has been undertaken primarily to obtain the “excluded amount” exemption under paragraph 120.4(1) in a manner that would frustrate the object, spirit and purpose of section 120.4, the CRA would seek to apply the GAAR.

We trust that these comments will be of assistance.

Yours truly,


Michael Cooke, CPA, CA
Corporate Reorganizations Section II
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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