TOSI and Paying Dividends to Your Spouse
This article will explain what tax on split income (TOSI) rules are. Specifically, we’ll look at how TOSI rules affect your ability to pay dividends to your spouse and adult family members.
In the past, owning an incorporated business in Canada gave owners the ability to save taxes by splitting income with an adult family member. This was often done by issuing dividends to a spouse who was in a lower personal tax bracket.
Tax on split income, or TOSI, is a new set of rules that reduces this benefit.
You’ll get a good understanding of how TOSI works in this article; however, we still recommend consulting with a tax professional before paying dividends to your spouse.
Here is what you need to know.
What is TOSI?
TOSI (tax on split income) is a set of tax rules that took effect on January 1, 2018. The rules are designed to limit the benefit of income splitting through private corporations.
TOSI rules apply when the income recipient is an adult family member and has not made a sufficient contribution to the business.
TOSI removes split income tax benefits by:
- Identifying some specific methods of income splitting that had previously reduced taxes, and
- Taxing that split income at the taxpayer’s highest marginal rate.
These rules are quite complex. They apply to dividend and interest income, but not salaries, paid by a private corporation.
Salaries are already subject to a reasonableness test - a tax deduction isn’t allowed to a business for amounts paid in excess of what is reasonable.
For the purposes of this article, we’re going to look at TOSI’s effects on the payment of dividends to a spouse or adult family member.
Can You Pay Dividends to Your Spouse?
The answer to this question is yes, but there will be negative tax consequences in certain scenarios. We’re going to look at a few of the most common scenarios and explain whether the negative tax effects of TOSI would apply.
Excluded Business - Spouse Sufficiently Contributes to the Business
An “excluded business” is the first scenario where TOSI would not apply. If the “excluded business” exception applies, paying dividends to your spouse is generally safe from tax on split income.
To be considered an excluded business, your spouse would need to be have provided sufficient contribution to the business.
What does sufficient contribution mean?
Example 1: Spouse Works 20+ Hours Per Week in the Current Year
One way for a spouse to sufficiently contribute is by working at least 20 hours per week on average while the business is operating.
Jennifer owns a personal tax accounting practice in Winnipeg. Her business is incorporated and her spouse is also a shareholder.
The business is actively operating from January to June providing personal tax services. During that period, her spouse works 25 hours per week doing admin work. During the rest of the year, both spouses live in Indonesia and no tax work is done.
In this case, Jennifer’s spouse is actively contributing to the business more than 20 hours per week while it operates. Jennifer can issue dividends to her spouse and the negative tax effects of TOSI won’t apply.
Note: I realize that it seems weird to live in Winnipeg for the winter and then spend the rest of the time in Indonesia, but they just really love extreme climates!
Example 2: Spouse Worked 20+ Hours Per Week for 5 Total Years
Another way for a spouse to sufficiently contribute is by having worked an average of 20+ hours per week for a total of 5 years. This applies even if the 5 years are not in succession.
Marty runs an incorporated delivery service. He and his wife, Tina, are the two shareholders of the company.
Tina worked as a delivery driver for 24 hours per week from 2010 to 2013 (3.5 years) before taking maternity leave. She then came back on as a delivery driver working 24 hours per week from 2015 to 2017 (2.5 years).
Tina then hung up her driving gloves and went back to school to become a Physiotherapist. She worked a total of 6.0 years at greater than 20 hours per week.
Tina has met one of the criteria for sufficient contribution. The company can pay her dividends now or anytime in the future without fear of TOSI taking effect.
How to Show Proof of an Excluded Business
The best way to prove that a spouse has met the excluded business criteria is to keep supporting documentation such as time sheets.
Proving sufficient contribution for the 5 year period (example 2 above) may be difficult if you haven’t kept solid records. CRA has commented that they realize this could be difficult. They noted that they will consider all information available about family members’ involvement in the business.
Excluded Shares - Spouse Owns at Least 10% of Votes and Value
This exclusion from TOSI is a bit more complicated. We’ll generally explain the criteria that need to be met for it to apply.
This exclusion from TOSI is met for the spouse shareholder if all of the following criteria are met:
- Age of Spouse - The spouse is 25 years of age or older.
- Percentage of Voting Shares Owned - The spouse shareholder owns at least 10% of the voting shares.
- Value of Voting Shares Owned - The spouse shareholder’s ownership represents at least 10% of the value of the corporation.
- Service Revenue - Less than 90% of the corporation’s revenue is from the provision of services. Services are not well defined for TOSI rules. For simplicity we’ll consider service revenue as: 1. Not the sale of a concrete thing 2. Requires face to face interaction
- Not a Professional Corporation - The corporation is not a professional corporation (think Doctors, Lawyers, Accountants etc.)
- Revenue from Related Business - No more than 10% of the company’s revenue earned from related businesses. Think of a related business as: 1. A related person is actively engaged in the business 2.A related person owns at least 10% of the business
There are a lot of moving pieces to this exclusion, so the idea here is to get a general awareness of it.
If you think that it applies to your situation, we recommend consulting with a tax professional before issuing dividends to your spouse.
Exclusion from TOSI for “Reasonable Returns”
If the criteria for excluded business or excluded shares exceptions can’t be met, there is another exception based on a reasonable return that can apply. It is limited to spouses and adult family members aged 25 or older.
Dividends can be paid to your spouse and not be subject to TOSI if the amount paid represents a reasonable return on their contribution to the business. In other words, the amount paid cannot be unreasonable when compared to your spouse’s overall contribution to the business.
What constitutes a reasonable return?
CRA takes into account a number of factors to determine whether dividends paid are reasonable compared to your spouse’s business contributions.
Reasonableness is based on:
- Labour Contribution - the amount of work performed by your spouse in support of the business.
- Property Contribution - the amount and value of property contributed by your spouse in support of the business.
- Risk Incurred - the risks assumed by your spouse in respect of the business.
- Historical Payments - the total amount that your spouse has historically received from the business.
- Other Factors - CRA will take other factors into account if they are relevant.
These criteria will be applied on a case-by-case basis, so it’s difficult to provide concrete examples of when this exception is met.
To provide some guidance, CRA has listed a number of TOSI examples on their website. If you scroll to the bottom of that page, you’ll also find further discussion of the reasonableness criteria.