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PricingService areasAll services →Paying Dividends To Your Spouse? Be Wary of TOSI (Tax On Split Income)
By Wajahat Ajmal
The article discusses the Tax on Split Income (TOSI) rules in Canada and their impact on paying dividends to spouses and adult family members from incorporated businesses. Keep in mind that Dividends can be paid to the holder of a class of Shares. For example, if both the spouses own Class A shares, you cannot issue Dividend to one shareholder and not to the other. Dividends are issued to a Class of shares. In this scenario, both the people will be issued Dividends as they own Class A shares which have been issued Dividends.
Table of Contents
Dividends to Your Spouse vs. TOSI
Prior to 1st January 2018, owning an incorporated business in Canada allowed business owners to reduce taxes by sharing income with an adult family member. This was commonly achieved by issuing dividends to a spouse in a lower tax bracket.
The new rules that took affect on 1st January 2018, on Tax on Split Income (TOSI) rules limited this advantage.
While this article will help you understand how TOSI works, it’s still advisable to consult a tax professional before paying dividends to your spouse.
Tax On Split Income (TOSI):
The Tax on Split Income (TOSI) rules in Canada aim to prevent income sprinkling, a strategy where high-income individuals divert income to family members in lower tax brackets, typically through dividends from private corporations. The TOSI rules apply to certain types of income earned by individuals from related business activities, particularly when the income is split among family members and they have not made a sufficient contribution to the business. TOSI eliminates the tax advantages of income splitting by:
- Targeting certain income-splitting strategies that previously lowered taxes, and
- Taxing the split income at the taxpayer’s highest marginal tax rate.
These rules are fairly intricate. They apply to dividend and interest income, but not to salaries, which are subject to a reasonability test paid by a private corporation.
Simply put, a business cannot claim a tax deduction for amounts paid as salaries that exceed what is reasonable.
Salaries are beyond the scope of this article as this article focuses on how TOSI impacts the payment of dividends to a spouse or adult family member.
So Can I Still Pay Dividends to My Spouse?
Yes, you still can but in certain scenarios, it can entail negative consequences. We’ll review some of the most common situations and explain whether the negative tax effects of TOSI would apply. Following the summary, each one is discussed in detail below:
- Excluded Shares – Spouse age is more than 25 years and certain conditions listed in the detail of this section are met.
- Excluded Business – Spouse is Actively Involved in the Business
- Reasonable Return – Returns received are reasonable, see this section for detail on this.
Excluded Shares - Spouse owns 10% of Voting Shares and Corporation Value
This exclusion from TOSI is somewhat complex. We’ll provide a general explanation of the criteria that must be met for it to apply.
The spouse shareholder can qualify for this exclusion if all of the following conditions are met:
- Age of Spouse: The spouse is 25 years old or older.
- Ownership of Voting Shares: The spouse holds at least 10% of the voting shares.
- Value of Voting Shares: The spouse’s shares represent at least 10% of the corporation’s value.
- Service Revenue: Less than 90% of the corporation’s revenue comes from providing services. For simplicity, service revenue can be seen as income from activities that involve face-to-face interaction and are not from selling physical goods.
- Not a Professional Corporation: The corporation is not a professional corporation (such as those for doctors, lawyers, or accountants).
- Revenue from Related Business: No more than 10% of the company’s revenue is earned from related businesses. A related business involves a person who is actively engaged or owns at least 10% of the business.
There are many factors involved in this exclusion, so this overview is intended to give a general understanding.
If you believe this applies to your situation, it’s best to consult a tax professional before issuing dividends to your spouse.
Excluded Business - Spouse Sufficiently Contributes to the Business
An “excluded business” is the other area where TOSI would not apply. If the excluded business exception applies, paying dividends to your spouse is generally exempt from split income tax.
To qualify as an excluded business, your spouse must have made a significant contribution to the business.
What does significant contribution mean?
Example 1: Spouse Works 20+ Hours Per Week in the Current Year
One way a spouse can contribute sufficiently is by working at least 20 hours per week on average during the period when the business is active.
For instance, Pete owns an electrician service business in Ontario, and his spouse, who is a shareholder, works 25 hours per week doing administrative tasks from January to December when the business operates.
In this case, since Pete’s spouse contributes more than 20 hours per week while the business is active, Pete can pay dividends to his spouse without triggering TOSI.
Example 2: Spouse Worked 20+ Hours Per Week for a Total of 5 Years
Another way to meet the sufficient contribution requirement is by having worked an average of 20+ hours per week for at least 5 years, even if the years are not consecutive.
Max owns an incorporated plumber service business, and his wife Deborah, who is a shareholder, worked as a driver for 24 hours per week from 2011 to 2014 (3.5 years). After taking a break, she resumed working 24 hours per week from 2016 to 2018 (2.5 years), completing 6 years in total at over 20 hours per week.
Deborah has met the criteria for sufficient contribution, allowing her to receive dividends without being affected by TOSI, now or in the future.
How to Show Proof of an Excluded Business
To demonstrate that a spouse meets the excluded business criteria, it’s important to keep supporting documents, such as timesheets.
Proving sufficient contribution over the 5-year period (as in example 2) may be challenging without detailed records. The CRA has acknowledged this difficulty and stated they will consider all available information regarding a family member’s involvement in the business.
Reasonable Return TOSI Exception
If the criteria for excluded business or excluded shares are not met, there is another exception based on a reasonable return that can apply. This exception is available to spouses and adult family members aged 25 or older.
Dividends can be paid to your spouse without triggering TOSI if the amount paid reflects a reasonable return on their contribution to the business. In other words, the payment must be fair in relation to your spouse’s overall involvement in the business.
What defines a reasonable return?
The CRA considers several factors to determine whether the dividends paid are reasonable in comparison to your spouse’s contributions to the business.
Reasonableness is determined by the following factors:
- Labour Contribution: The amount of work your spouse has performed for the business.
- Property Contribution: The amount and value of property your spouse has provided to support the business.
- Risk Incurred: The risks your spouse has taken in relation to the business.
Historical Payments: The total amount your spouse has previously received from the business. - Other Factors: CRA will consider other relevant factors if applicable.
These criteria are evaluated on a case-by-case basis, making it difficult to provide specific examples of when this exception is met.
For guidance, the CRA has provided several TOSI examples on their website. Scroll at the bottom of the page, you’ll also find a more detailed discussion of the reasonableness criteria.
This rules are fairly complex and depend on the scenarios you face. It is always recommended to consult with a professional before moving forward to add your Spouse or Family member as a Shareholder.
T-Ledgers Newsletter
The article discusses the Tax on Split Income (TOSI) rules in Canada and their impact on paying dividends to spouses and adult family members from incorporated businesses. Keep in mind that Dividends can be paid to the holder of a class of Shares. For example, if both the spouses own Class A shares, you cannot issue Dividend to one shareholder and not to the other. Dividends are issued to a Class of shares. In this scenario, both the people will be issued Dividends as they own Class A shares which have been issued Dividends.
Table of Contents
Dividends to Your Spouse vs. TOSI
Prior to 1st January 2018, owning an incorporated business in Canada allowed business owners to reduce taxes by sharing income with an adult family member. This was commonly achieved by issuing dividends to a spouse in a lower tax bracket.
The new rules that took affect on 1st January 2018, on Tax on Split Income (TOSI) rules limited this advantage.
While this article will help you understand how TOSI works, it’s still advisable to consult a tax professional before paying dividends to your spouse.
Tax On Split Income (TOSI):
The Tax on Split Income (TOSI) rules in Canada aim to prevent income sprinkling, a strategy where high-income individuals divert income to family members in lower tax brackets, typically through dividends from private corporations. The TOSI rules apply to certain types of income earned by individuals from related business activities, particularly when the income is split among family members and they have not made a sufficient contribution to the business. TOSI eliminates the tax advantages of income splitting by:
- Targeting certain income-splitting strategies that previously lowered taxes, and
- Taxing the split income at the taxpayer’s highest marginal tax rate.
These rules are fairly intricate. They apply to dividend and interest income, but not to salaries, which are subject to a reasonability test paid by a private corporation.
Simply put, a business cannot claim a tax deduction for amounts paid as salaries that exceed what is reasonable.
Salaries are beyond the scope of this article as this article focuses on how TOSI impacts the payment of dividends to a spouse or adult family member.
So Can I Still Pay Dividends to My Spouse?
Yes, you still can but in certain scenarios, it can entail negative consequences. We’ll review some of the most common situations and explain whether the negative tax effects of TOSI would apply. Following the summary, each one is discussed in detail below:
- Excluded Shares – Spouse age is more than 25 years and certain conditions listed in the detail of this section are met.
- Excluded Business – Spouse is Actively Involved in the Business
- Reasonable Return – Returns received are reasonable, see this section for detail on this.
Excluded Shares - Spouse owns 10% of Voting Shares and Corporation Value
This exclusion from TOSI is somewhat complex. We’ll provide a general explanation of the criteria that must be met for it to apply.
The spouse shareholder can qualify for this exclusion if all of the following conditions are met:
- Age of Spouse: The spouse is 25 years old or older.
- Ownership of Voting Shares: The spouse holds at least 10% of the voting shares.
- Value of Voting Shares: The spouse’s shares represent at least 10% of the corporation’s value.
- Service Revenue: Less than 90% of the corporation’s revenue comes from providing services. For simplicity, service revenue can be seen as income from activities that involve face-to-face interaction and are not from selling physical goods.
- Not a Professional Corporation: The corporation is not a professional corporation (such as those for doctors, lawyers, or accountants).
- Revenue from Related Business: No more than 10% of the company’s revenue is earned from related businesses. A related business involves a person who is actively engaged or owns at least 10% of the business.
There are many factors involved in this exclusion, so this overview is intended to give a general understanding.
If you believe this applies to your situation, it’s best to consult a tax professional before issuing dividends to your spouse.
Excluded Business - Spouse Sufficiently Contributes to the Business
An “excluded business” is the other area where TOSI would not apply. If the excluded business exception applies, paying dividends to your spouse is generally exempt from split income tax.
To qualify as an excluded business, your spouse must have made a significant contribution to the business.
What does significant contribution mean?
Example 1: Spouse Works 20+ Hours Per Week in the Current Year
One way a spouse can contribute sufficiently is by working at least 20 hours per week on average during the period when the business is active.
For instance, Pete owns an electrician service business in Ontario, and his spouse, who is a shareholder, works 25 hours per week doing administrative tasks from January to December when the business operates.
In this case, since Pete’s spouse contributes more than 20 hours per week while the business is active, Pete can pay dividends to his spouse without triggering TOSI.
Example 2: Spouse Worked 20+ Hours Per Week for a Total of 5 Years
Another way to meet the sufficient contribution requirement is by having worked an average of 20+ hours per week for at least 5 years, even if the years are not consecutive.
Max owns an incorporated plumber service business, and his wife Deborah, who is a shareholder, worked as a driver for 24 hours per week from 2011 to 2014 (3.5 years). After taking a break, she resumed working 24 hours per week from 2016 to 2018 (2.5 years), completing 6 years in total at over 20 hours per week.
Deborah has met the criteria for sufficient contribution, allowing her to receive dividends without being affected by TOSI, now or in the future.
How to Show Proof of an Excluded Business
To demonstrate that a spouse meets the excluded business criteria, it’s important to keep supporting documents, such as timesheets.
Proving sufficient contribution over the 5-year period (as in example 2) may be challenging without detailed records. The CRA has acknowledged this difficulty and stated they will consider all available information regarding a family member’s involvement in the business.
Reasonable Return TOSI Exception
If the criteria for excluded business or excluded shares are not met, there is another exception based on a reasonable return that can apply. This exception is available to spouses and adult family members aged 25 or older.
Dividends can be paid to your spouse without triggering TOSI if the amount paid reflects a reasonable return on their contribution to the business. In other words, the payment must be fair in relation to your spouse’s overall involvement in the business.
What defines a reasonable return?
The CRA considers several factors to determine whether the dividends paid are reasonable in comparison to your spouse’s contributions to the business.
Reasonableness is determined by the following factors:
- Labour Contribution: The amount of work your spouse has performed for the business.
- Property Contribution: The amount and value of property your spouse has provided to support the business.
- Risk Incurred: The risks your spouse has taken in relation to the business.
Historical Payments: The total amount your spouse has previously received from the business. - Other Factors: CRA will consider other relevant factors if applicable.
These criteria are evaluated on a case-by-case basis, making it difficult to provide specific examples of when this exception is met.
For guidance, the CRA has provided several TOSI examples on their website. Scroll at the bottom of the page, you’ll also find a more detailed discussion of the reasonableness criteria.
This rules are fairly complex and depend on the scenarios you face. It is always recommended to consult with a professional before moving forward to add your Spouse or Family member as a Shareholder.
