hand grabbing money bag

Canada Revenue Agency officials provided tax experts with little relief from difficulties they may be experiencing in interpreting complex new legislation governing the taxation of income paid from a small business during a roundtable discussion at the annual national conference of the Canadian arm of the Society of Trust and Estate Practitioners (STEP Canada) in Toronto last week.

Indeed, Phil Kohnen, manager of the trusts section in the CRA’s income tax rulings directorate, acknowledged during the discussion that he was not in a position to give “clear and definite directions” to specific questions from panellists relating to the new tax on split income [TOSI] rules, which became effective Jan. 1.

However, Kohnen did suggest that certain exclusions provided in the legislation that would allow small-business owners to split income should be considered “bright line” tests and that taxpayers would be better off relying first on the “reasonable return” exclusion to determine whether income paid out of the small business would fall under the TOSI rules.

“It would be probably be wise or good advice in many cases to at least determine if an amount is excluded from the TOSI rules because it’s a reasonable return of the individual and therefore not have to look at the excluded shares definition,” he said.

The TOSI rules, which the federal government introduced last year, eliminated many of the ways in which small-business owners had been able to split dividend income paid out of a private corporation to family members. However, the new rules do provide for certain exclusions from TOSI — including the “reasonable return” and “excluded shares” exclusions.

In terms of the reasonable return exclusion, the TOSI rules will not apply if a family member receives dividend income considered to be a reasonable amount in relation to the contribution of that family member to the business. The manner in which the CRA determines if the return is reasonable differs depending on the age of that family member and his or her contribution to the business.

The excluded shares provision allows for income splitting with a family member aged 25 or older who owns more than 10% of both the voting shares and value of the private corporation. However, the exclusion is not available for professional corporations or for businesses in which more than 90% of the income is from the provision of services.

In answering a question from a panellist regarding the interpretation of rules governing the excluded shares provision, Kohnen said that, in general, gross income, rather than net income, would be regarded as business income for purposes of determining the application of the exclusion. He also suggested that small businesses would have to keep track of income from service and non-service business in order to apply for the excluded shares provision.

“In a scenario [in which] the corporation has income from provision of services and from non-service, and has non-service income as well, the two should generally be computed separately, and the non-service income considered in determining if the requirement of the [excluded shares] definition is met,” said Kohnen, adding that the determination could be affected if the “non-service income was necessary but incidental to the provision of the services themselves.”

Answering two other questions related to the excluded shares provision, panellist Steve Fron, manager of the trusts section in the income tax rulings directorate of the CRA, confirmed that shares of a holding company would generally not qualify as “excluded shares,” and that in a scenario in which a corporation had no business income, its shares would not qualify as excluded shares.

Meanwhile, tax practitioner and panellist Kim Moody of Moodys Gartner Tax Law in Calgary expressed his overall frustration with the complexity of the new draft legislation governing the taxation of small businesses, characterizing it as “horrific.”

Said Moody: “Every time I’m presented with a [taxpayer’s] fact situation, I have to pick up the legislation and start from scratch. It’s something I really struggle with on a day-to-day basis.”