Sav rbc presentation- tax on split income and passive income rules v4 fdis

RBC Advice Event for Small
Business Owner Week
Recent Tax changes impacting small business owners
Tax on Split Income
and
Tax impact of passive Income
October 18, 2018
SAV Associates
Chartered Professional Accountants
RBC – Royal Bank of Canada
Yonge and Hollywood Branch
5001 Yonge Street, 2nd Floor
North York, Ontario M2N 6P6

Disclaimer
This material is for educational purposes only.
As it deals with technical matters which have
broad application, it is not practical to include
all situations. As well, the course material and
the references contained therein reflect laws
and practices which are subject to change. For
this reason a particular fact situation should be
reviewed by a qualified professional.
Although the course material has been
carefully prepared, none of the persons
involved in the preparation of the material
accepts any legal responsibility for its contents
or for any consequences arising from its use.

LET OUR EXPERIENCE AND COMMITMENT GET
YOU THE VALUE YOU DESERVE
Presented by
Sanjay Chadha CPA, CA, MBA
647 831 8322
sanjaychadha@savassociates.ca
CONFIDENTIAL- CONTENT OF THIS PRESENTATION IS NOT AN ADVICE AND SHOULD TO BE USED FOR EDUCATIONALPURPOSES ONLY

ACCOUNTING
ASSURANCE
TAXATION
BUSINESS ADVISORY
RISK ADVISORY
SAV Associates is a Toronto based Chartered Accountant firm
serving the needs of Small Business Owners & Entrepreneurs in
Toronto, North York and GTA (Greater Toronto Area).
Tailor-made Services to Entrepreneurs and small businesses
Remaining on the cutting edge of tax law, financial trends and
regulatory changes
We are supported by a team of professionals who are
nationally and internationally certified and have wealth
of experience and can provide true business consulting.
Our goal is to provide our clients with personalized
solutions designed to meet their specific needs
We value efficient, honest service that achieves
remarkable results.

Agenda
Tax on Split
Income
Passive Income
and Small
Businesses
Confidential - Content of this presentation is not an advice and
should to be used for educational purposes only

Tax on Split Income
SAV Associates
Charted Professional Accountants

Tax on Split
Income (TOSI)
Old Rules- Pre 2018 (widely known as Kiddie Tax)
• Family members (Canadian resident) under 18 years of
age. Had a parent residing in Canada during the year.
• Purpose - Splitting income among family members of a
Canadian owned corporation
• Type of Income – Private company dividends,
shareholder loan, partnership income run by a related
person, income from Trust that is traced to one of the
sources above
• Intention – Tax planning arrangement to reducing overall
tax paid to the CRA for Income tax purposes
Result:
Income was taxed at the highest marginal rate in recipient
individual’s hand (in Ontario upto 53.5%)

Tax on Split
Income
(TOSI)- Old
Rules
Example
Scenario 1
One Person Corporation
Profit: $100,000
Total Tax Liability: apx 35%

Tax on Split
Income (TOSI)-
Old Rules
Example
A One-Person Corporation
Scenario 2
Splitting Income among family members to reduce tax by
paying dividend the family members
The owner
Spouse
Child 1 – over 18years old
Child 2 – under 18 years old

Current
Legislative Limits
in ITA – Income
Splitting
Income splitting was accepted by Supreme Court of Canada in
Neuman v Queen Decision
Tax Rules limiting income splitting
• Section 67 – Deduction from income must be reasonable.
• Sections 56, 74.1 to 75.1 – Income attributed back to
transferor.
• Sections 15, 246 and subsection 56(2) – Tax benefit
conferral
• Section 74.4 – Imputes income where attribution done
indirectly through corporations.
• Sections 74.1 and 60.03 – explicit permission for seniors to
split CPP and eligible pension income.
• December 13, 2017 proposal significantly expands the
scope of the TOSI rules.

Tax on Split
Income(TOSI)
Decision Tree
Flow Chart

Tax on Split
Income(TOSI)
- New Rules
as of January
2018
“specified individual” - Rules expanded to include Canadian resident
family members (spouses, minor and adult children, parents and
siblings) for split income purposes
“related business” - For individuals 18 or over, rules only apply if an
amount (i.e. dividend, capital gain or interest) is derived directly or
indirectly from a “related business”
“Source individual” is an individual who at any time in the year is
resident in Canada and is related to the specified individual
“Related” if individual is your mother, father, spouse, son, daughter,
brother, and sister and any of the above as a result of marriage (e.g. son-
in-law)
For TOSI to apply (at a high level) - the business is operated by a
corporation and the source individual owns at least 10% of the total fair
market value of the corporation
If there is no business, TOSI rules may not apply

Tax on Split
Income(TOSI)
- New Rules
as of January
2018
taxable dividends from corporations (non – listed)
income derived directly or indirectly from a “related
business” – (provided services / property or disposition of
interest in business)
income from the rental of property if a related person is
actively engaged on a regular basis in the activities or owns
an interest in the partnership or trust
interest, if other amounts would be classified as TOSI income
capital gains realized on properties the income from which is
specified as TOSI income

Tax on Split
Income(TOSI)
- New Rules
as of January
2018
ey.com
Section 120.4(2) “Split
Income” ITA
Where a specified individual
earns split income, there will
be a tax applied at the top
marginal rate
Split Income X Top Marginal
Tax Rate

Tax on Split Income(TOSI) - New Rules
Example
XYZ Corporation Inc Dividend paid to
daughter: $100,000
Only Source of
daughter’s Income
(over 18years old)
Daughter does not
work in the
business
Under older rules:
Apx $ 17,000
Under new rules: $
Highest Marginal
rate

Excluded
Amounts
=
No TOSI
Income is considered excluded if one or
some of the following conditions are met:
• Inheritance Exception (Under 25 years of age) – parent of
an individual or any person if individual is full time
student
• Breakdown of relationship (Divorce) exception
• Death exception – taxable capital gain arising as a result
of death
• Income from excluded business or not related business if
18 or older
• Safe harbor capital return exception (between 18 to 24) –
reasonable return on arm’s length capital
• Reasonable return exception (over 24 years) – work
performed, property contribution, risk assumed etc.
• Unlimited Income Splitting allowed if Individual with a
contributing spouse age 65 or over in the present year
OR has died

Income from
Excluded
Business
=
No TOSI
No TOSI - if business is excluded business
and individual is 18 or older
• for all amounts other than capital gains, individual must
be actively engaged (average 20 hours per week), on a
regular, continuous and substantial basis in the year or
any 5 previous years
• for capital gains, in any 5 previous years – if business sold
after 3 years, in business – “Tricky” - may be challenged

Income from
Excluded
Shares
=
No TOSI
No TOSI - if 24 or older before the year and
shares are excluded shares
• less than 90% of business income is from services (business
income);
• corporation is not a professional corporation (accountant,
dentist, lawyer, medical doctor, veterinarian or chiropractor);
• individual owns 10% or more of votes and value of
corporation; and
• income of the corporation not derived directly or indirectly
from another related business – Probably to prevent business
being split into two businesses and letting specified individual
own shares in non-service business
For 2018 only, 10% votes and value must be met either before
the relevant time or by the end of 2018

Possible Consideration to avoid TOSI
• Salaries
• Consider Capital Gain Exemption crystallizations
• Convert professional corporation to a regular CCPC if it is no longer
active
• Restructure to fit within “excluded shares” definition
• TOSI vs Income Attribution (unreasonable salary)
• More option when entrepreneur turns 65

Passive Investment Income and
Its Impact on Small Business Tax
Reduction
Presented by
Sanjay Chadha
SAV Associates
Charted Professional Accountant

Grind on Small
Businesses Limit
In 2018, tax on small business income at 10
percent federally
To be reduced to 9 percent in 2019
Small business limit $500,000 federally and in
most provinces (provided capital employed is
less than 10 Million)
Under the Proposals, the small business limit
will be reduced by $5 for every $1 of
investment income above a $50,000 threshold
Therefore, the Small Business Deduction Rules
(SBD) will be eliminated when investment
income reaches $150,000
Purpose -
• To remove perceived
advantage of corporations’
ability to invest in passive
investment using earnings
that were subject to
corporate tax rates (as
opposed to having to invest
with earnings subject to the
much higher personal income
tax rate).
• Therefore, to promote
fairness and neutrality, under
the new regime, earning
passive income through a
corporation or personally
should yield the same after-
tax return.
• Targets private corporations
only.

CRA Rules on Passive Income for Small
Businesses
The Small Business Deduction Rules (SBD) reduces
the corporate income tax that a corporation would
otherwise have to pay in a taxation year
throughout which it was a Canadian-controlled
private corporation (CCPC). A corporation’s SBD for
a taxation year is generally calculated by
multiplying its SBD rate by the lesser of its:
income for the year from an active business
carried on in Canada, excluding certain income
and exceeding certain losses;
taxable income for the year (including associated
corporations)
business limit for the year (To be tested every
year)

Calculating CCPC’s Passive Business Limit
Reduction
• A CCPC’s passive income business limit reduction for a
particular taxation year will be the amount determined
by the formula:
• BL/$500,000 x 5 (AAII - $50,000)
• where
• BL is the CCPC’s business limit otherwise determined for
the particular year (i.e., its business limit as described
above); and
• AAII is the total of all amounts each of which is the
adjusted aggregate investment income of the CCPC, or of
any corporations with which it is associated at any time in
the particular year, for each of their taxation years that
ended in the preceding calendar year.
https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2018-equality-
growth-strong-middle-class/passive-investment-income/small-business-deduction-rules.html
• The clawback limit pertains to the
amount of investment income, and not
on the amount of small business income
in the corporation.

Calculating
CCPC’s Passive
Business Limit
Reduction
Example
ABC Company is a CCPC having a December 31,
2020, taxation year end, and is not associated with
any other corporations in the year. ABC Company’s
adjusted aggregate investment income for its
December 31, 2019, taxation year was $75,000.
ABC Company’s passive income business limit
reduction for its 2020 taxation year is determined
as follows:= $500,000/$500,000 x 5($75,000 -
$50,000)= 1 x 5($25,000)=$125,000
Consequently, ABC Company’s business limit for its
December 31, 2020, taxation year will be reduced
from $500,000 to $375,000 (i.e., $500,000 -
$125,000)
If a corporation has $150,000 of
business income and $75,000 of
investment income, the clawback
will be 5 x ($75,000-$50,000), or
$125,000. This will reduce the small
business limit to $375,000. Since the
corporation has only $150,000 of
small business income, it will be
fully eligible for the small business
deduction.

Calculating
CCPC’s
Passive
Business Limit
Reduction
Example 2
Same facts as Example 1 in last slide,
except that ABC Company is associated
with XYZ Company, which had $55,000
of adjusted aggregate investment
income in its December 31, 2019,
taxation year. The entire business limit
for the 2020 taxation year was
allocated to ABC Company.
ABC Company’s passive income
business limit reduction for its 2020
taxation year is determined as
follows:= $500,000/$500,000 x
5(($75,000+$55,000) - $50,000)= 1 x
5($80,000)=$400,000
Consequently, ABC Company’s
business limit for its December 31,
2020, taxation year will be reduced
from $500,000 to $100,000 (i.e.,
$500,000 - $400,000).

Investment Income measured by Adjusted
Aggregate Investment Income
Capital gains (and losses) on
disposition of property
Non active rental income Income earned from savings in
a non-exempt life insurance
policy
Dividend, capital gains and
interest received from an
investment
Excludes: Capital gains - on
property used in an active
business; disposition of shares to
connected CCPC; NCL C/F from
other years and Dividends from
connected corporations

2018 Corporate
Income Tax
Rates for Active
Business Income
ey.com

THANK YOU
HULLMARK CENTRE AT YONGE AND SHEPPARD
3M-4773 YONGE STREET, TORONTO, ON, M2N 0G2
TEL: 647.831.8322
416.822.8570
EMAIL: INFO@SAVASSOCIATES.CA
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Sav rbc presentation- tax on split income and passive income rules v4 fdis

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