Four TOSI exceptions available to farmers
Before new legislation was introduced in 2017 (effective January 2018), tax on split income (TOSI) only applied to minors. Previously, if private corporation dividend income was allocated to someone under the age of 18, that income would be taxed at the highest marginal tax rate. (This is currently 33 per cent federally, with combined federal and provincial/territorial rates ranging from 47.5 per cent to 54 per cent on regular income). The new TOSI rules now apply that treatment to any family member, not just minors. Under the new rules, the top marginal tax treatment can be extended to adult children or spouses who aren’t actively involved in a business, dramatically broadening this category. While this change in the rules has the potential to be quite expensive for many farm businesses, we have found for most cases it is relatively easy to apply at least one of the following four exceptions.
1. The excluded business exception
If a family member is involved in a business on a regular and continuous basis, they are exempt from the TOSI treatment. If they are paid a dividend, it is taxed at their normal tax rate. In this exception, there is a bright line test. If someone works an average of 20 hours a week throughout the year, they are deemed to be active enough to receive that treatment. If they meet the test in the year they are paid that dividend, they qualify. In addition, if they have five good years where they meet that test (these years don’t have to be consecutive) then they qualify permanently going forward.
This test is easier to meet for farmers than those in other industries because of the nature of their work. It is not uncommon for a farmer’s children to work on the family farm in the summer, whether they’re in high school, college or university. Typically, this is also when things are busiest on the farm, making it much more likely a farmer’s children will be able to meet this exception.
2. The excluded share exception
If your shares make up 10 per cent of the corporation’s overall value and also 10 per cent of the corporation’s overall votes of the shares, they are excluded from the application of TOSI. For example, consider a farm corporation owned by two spouses where one is not involved in the day-to-day work. If the uninvolved spouse has shares worth 15 per cent of the farm’s value and 15 per cent of the votes of the total shares, they can be paid dividends without TOSI applying because they exceed 10 per cent on both tests. However, for this exception to apply, they have to own the shares directly and not through a family trust (the excluded business exception is different in that the shares do not have to be held directly).
In addition, there are a few other criteria to be met for the excluded share exception. For example, the exception can’t be accessed by a service business (not a major concern for farmers, as a farm is rarely considered a service business). Even if you have income from custom work like harvesting or planting for other farmers, it’s still a small percentage of your overall income when you factor in crop or milk sales.
3. Shares eligible for the capital gains exemption
In addition to dividends, TOSI can also apply to capital gains on selling shares. However, any time you have a sale of shares eligible for the capital gains exemption, TOSI will not apply. If a farm corporation meets the definition of what’s called a family farm corporation, the sale of those shares is eligible for the capital gains exemption based on a 90 per cent test. If 90 per cent of the corporation’s assets (at fair market value) are used in the farming business, those shares are eligible for the capital gains exemption. If you sell shares that are eligible, TOSI doesn’t apply.
If you don’t have enough capital gains exemption to shelter the full gain, TOSI still doesn’t apply, even if the capital gains exceed the exemption limit on farm property ($1 million). If you have an inactive shareholder who owns $2 million worth of shares and sells them, the gains exemption is only available for the first million – but TOSI still doesn’t apply to the second million because the shares are eligible.
4. The active shareholder is 65 years of age or older
When the first draft of the TOSI rules was released, many complained about the absence of an income-splitting exception for senior shareholders of private corporations. If not for this change, people who owned private corporations could have been subject to less favourable rules than those who could split their pension income.
In a situation where you have one spouse who’s active in the business and one who is not, even if the latter doesn’t meet the excluded shares test or the business test, as long as the spouse who’s actively involved is 65 or older, dividends can be paid to the inactive spouse without TOSI applying. In this case, they don’t need to have a certain percentage of shares. As long as they own at least one share that dividends can be paid on and their spouse is 65 or older and active in the business, they are exempt from the TOSI rules.
Luther VanGilst
Luther VanGilst