Starting on Jan. 1, 2018, changes to the Income Tax Act regarding income sprinkling take effect. While the changes only affect a small percentage of Canadians, it’s important for you to understand the new income sprinkling rules and how they may apply to your young business clients.
What Is Income Sprinkling and Who Is Affected by the New Rules?
Income sprinkling is another term for income splitting. It’s a strategy used by high-income owners of private corporations to pass on income to immediate family members with lower tax rates. This is usually done by arranging the corporation’s ownership share structure in a way that spouses or children share ownership. Company income, which includes dividends and capital gains, can then be passed on to family members and taxed at lower rates. In some cases, the income realized by family members might not be taxable at all.
Canadians directly affected by the new income sprinkling rules include those who have incorporated, formed a Canadian-controlled private corporation, also known as a CCPC, and currently use income sprinkling to reduce their family’s overall tax bill.
What Changes Are Now in Place?
Current tax rules on “Tax on Income Split” (TOSI) apply to the highest marginal tax rate of family members under the age of 18, allowing income to be split with these family members for federal tax purposes. It’s now proposed to extend the TOSI rules to family members over the age of 17 but only with respect to income derived from a related business. Also proposed is the idea to extend the actual definition of “split income” to encompass certain income received from debt obligations and certain types of taxable capital gains.
Age Groups and Active Involvement
If a spouse, child, or sibling is over 17 years old and not actively involved in the business, dividends received from the private corporation may be split. According to the Canada Revenue Agency, an individual is actively involved with the business if he was involved on a “regular, continuous and substantial” basis in the year taxes are filed, or any year in the previous five years. An individual is involved on a regular, continuous, and substantial basis if he worked an average of 20 hours a week in those years. The CRA suggests that business owners keep active timesheets for everyone working in the business.
These rules do not apply to individuals at least 25 years old who own at least 10 percent in the family business. In addition, the business must not be an accounting, legal, medical, or dental business. In general, the corporation must not be a service business. The above rules also do not apply to spouses 65 and older. More details about the new income sprinkling rules and exceptions can be found on the section of the CRA’s website about income sprinkling.
Overall, the new income sprinkling rules are in place to begin many tax loopholes that give CCPC owners and their families tax advantages that aren’t available to all Canadians. Try to gain a more thorough understanding of these new rules and how they are likely to negatively affect your clients who take advantage of income sprinkling.