TOSI rules in Canada: a plain-language guide for family businesses

If you pay dividends, interest, or partnership income to a family member connected to your private corporation, the Tax on Split Income (TOSI) rules under section 120.4 of the Income Tax Act may tax that payment at the highest federal marginal rate, regardless of the recipient’s actual income. The single most important action you can take right now is to pause any new discretionary dividend payments to family members until you have confirmed which exclusions apply and gathered contemporaneous records proving their involvement.

Before your next family dividend payment, do these two things:

Check whether the recipient qualifies under an exclusion (excluded business, excluded shares, or reasonable return) using CRA’s guidance on split income rules for adults and Form T1206.
Gather dated records of the family member’s work hours, capital contributions, and any formal agreements before the payment is made, not after.

Key takeaways

TOSI taxes certain family-connected income at the top marginal rate under section 120.4 of the Income Tax Act, and the only reliable defence is an exclusion supported by contemporaneous documentation.

Point	Details
TOSI triggers	Dividends, certain capital gains, and related-party income from private corporations paid to connected family members.
Age determines exclusions	Recipients under 18 have almost no relief; those 25 and over can access excluded business, excluded shares, and reasonable return tests.
Excluded shares threshold	The recipient must own at least 10% of votes and value, and the corporation must pass the 90% gross income test.
Documentation is the defence	Contemporaneous records of hours, capital, and resolutions created before payment are the most critical factor in a CRA audit.
T-Ledgers can help	T-Ledgers offers flat-rate virtual CFO and tax filing services to review TOSI exposure and support compliant family-income planning.

What TOSI is and what income it actually captures
Who TOSI applies to: specified individuals and age brackets
The core exclusions: which tests remove income from TOSI
How to calculate and report TOSI on your return
Practical planning options that keep your family income lawful
Audit risks, CRA red flags, and your documentation checklist
What to do right now if you are unsure whether TOSI applies
How TOSI affects the overall family tax picture
Penalties and interest for TOSI non-compliance
How TOSI interacts with provincial tax rules in Saskatchewan
TOSI in estate planning and for deceased individuals
Why documentation is the real TOSI strategy
How T-Ledgers can help you manage TOSI risk
Sources
FAQ

What TOSI is and what income it actually captures

TOSI is the federal tax mechanism that prevents high-income business owners from reducing their family’s overall tax bill by shifting income to lower-bracket relatives. The rules have applied in their current, expanded form since the 2018 tax year, following the Department of Finance’s 2017 consultation paper, Tax Planning Using Private Corporations, which proposed closing what the government viewed as aggressive income-splitting arrangements.

The statutory authority is section 120.4 of the Income Tax Act. When TOSI applies, the income is taxed at the top federal marginal rate in the recipient’s hands, and most personal tax credits (other than the basic personal amount and the dividend tax credit, which is itself limited) cannot offset it.

Income types that can trigger TOSI:

Dividends from private corporations (the most common trigger for family businesses)
Certain taxable capital gains from shares of private corporations
Income allocated through partnerships or trusts that is derived from a related business
Shareholder benefits under section 15 of the Income Tax Act
Interest income on certain debt obligations of private corporations, related-party loans, and trust allocations

What TOSI does not capture:

Salary or wages paid to a family member (these are reviewed under the reasonableness test in section 67 of the Income Tax Act, not TOSI)
Income from publicly traded shares
Excluded amounts that meet one of the statutory tests described below

A practitioner handbook on TOSI notes that the rules also reach income from certain debt obligations of private corporations, trusts, and partnerships, so owners should review shareholder loans, related-party interest, and trust allocations when assessing their exposure.

Key legal reference: CRA administers TOSI under s.120.4 of the Income Tax Act. Amounts subject to TOSI are reported on Form T1206 and flow to Line 40424 of the T1 personal return. CRA’s guidance document, Guidance on the application of the split income rules for adults, is the primary administrative reference for exclusions and examples.

Who TOSI applies to: specified individuals and age brackets

TOSI applies to a “specified individual,” which is any Canadian resident who receives income from a “related business.” A related business is generally one in which a family member (spouse, parent, sibling, or child) is actively engaged or holds a significant interest. For a Saskatchewan family running a private corporation, this typically means any family member receiving dividends from the company is a specified individual unless an exclusion applies.

Practical scenarios:

A spouse who holds shares but works full-time elsewhere and receives dividends from the family business is a specified individual.
An adult child who owns shares in the family corporation and receives a dividend allocation is a specified individual.
A trust that distributes income to minor or adult beneficiaries connected to the business is caught unless the trust itself qualifies for an exclusion.

Age determines which exclusions are available, and the rules become progressively more flexible as recipients get older.

Age group	TOSI applies?	Key tests available
Under 18	Yes (original “kiddie tax”)	Very limited; excluded business test rarely met
18–24	Yes, with limited relief	Safe-harbour capital return; arm’s-length capital limit
25 and over	Yes, but more exclusions available	Excluded business; excluded shares; reasonable return

An RSM Canada technical paper emphasises that distinguishing whether income is derived from a “related business” requires a facts-and-circumstances analysis, particularly when the corporation earns a mix of active business income and passive investment income.

The core exclusions: which tests remove income from TOSI

Satisfying even one of the following exclusions removes the income from TOSI entirely. Each test has specific criteria, and CRA applies them strictly.

Excluded business (actively engaged test)

A family member’s income is excluded if they are “actively engaged on a regular, continuous, and substantial basis” in the business. CRA treats working at least 20 hours per week during the part of the year the business operates as a safe harbour. There is also a five-year lookback: if the individual was actively engaged in any five prior years (not necessarily consecutive), the exclusion can apply in later years even if their hours have since dropped.

For a Saskatchewan farm family or a small professional practice, this test is often the most practical route. The catch is documentation: you need timesheets, schedules, or other contemporaneous records showing the hours worked.

Excluded shares (for individuals 25 and over)

Under CRA’s excluded shares guidance, shares qualify as excluded shares when all of the following conditions are met:

The recipient is 25 or older.
The recipient owns shares representing at least 10% of the votes and 10% of the fair market value of all issued shares of the corporation.
The corporation is not a professional corporation (law, medicine, accounting, etc.) and does not earn more than 90% of its business income from services provided to a small number of related persons.
Less than 90% of the corporation’s gross business income comes from one or more other related businesses (the 90% gross income test).

This last point is the one most commonly missed. If your corporation primarily invoices another family-owned company, the excluded shares test may fail even if the ownership thresholds are met.

Reasonable return

For individuals 25 and over, a dividend is excluded to the extent it is “reasonable” given the individual’s labour contribution, property contributed, risks assumed, historical payments, and any other relevant factors. CRA does not publish a formula; it weighs all the circumstances. A spouse who invested $200,000 in the business and has taken on personal guarantees on corporate debt has a stronger reasonable-return argument than one who contributed no capital and performs no work.

Safe-harbour capital return (ages 18–24)

For individuals aged 18–24, a limited exclusion applies to returns on capital they personally contributed at arm’s length. The excluded amount is calculated using the prescribed interest rate, applied to the individual’s contributed capital. This is a narrow relief and rarely covers the full dividend in practice.

Decision checklist before paying a family dividend:

Is the recipient a specified individual connected to a related business? If no, TOSI does not apply.
Is the recipient under 18? If yes, TOSI almost certainly applies; consult a tax professional.
Is the recipient 18–24? Check the safe-harbour capital return calculation and arm’s-length capital rules.
Is the recipient 25 or older? Work through the excluded business test, excluded shares test, and reasonable return analysis in that order.
Can you document the basis for the exclusion with records created before or at the time of payment?

How to calculate and report TOSI on your return

TOSI is not a separate tax return; it is an additional federal tax calculated within the T1 personal return of the recipient. Here is how the reporting works in practice.

Step-by-step reporting:

Step 1: Identify all amounts received during the year that may be split income (dividends, partnership allocations, trust distributions, interest from private corporations).
Step 2: Complete Form T1206, Tax on Split Income. The form walks through each income type and applies the applicable exclusions to arrive at the net split income amount.
Step 3: The resulting federal TOSI amount flows to Line 40424 of the T1 return. This amount is added to the recipient’s regular federal tax, not offset by most credits.
Step 4: For individuals who earned income in more than one province or territory during the year, Form T2203 (Provincial and Territorial Taxes for Multiple Jurisdictions) may also be required to calculate the provincial portion of the tax correctly.
Step 5: Note that the dividend tax credit is available only to the extent of the regular tax otherwise payable; it cannot reduce TOSI below zero. Foreign tax credits are similarly restricted.

The expanded TOSI rules apply to tax years beginning on or after January 1, 2018. CRA’s income sprinkling FAQ confirms that CRA expected taxpayers to file on the basis of the proposed legislation from 2018 onward, and Form T1206 was updated to reflect the expanded rules.

Practical planning options that keep your family income lawful

The goal is not to avoid paying family members; it is to structure those payments so they survive CRA scrutiny. There are several approaches that work, and a few that consistently fail.

What works:

Salary backed by real work: Paying a family member a salary for genuine services is not subject to TOSI. The salary must be reasonable under section 67, meaning it should approximate what you would pay an arm’s-length employee for the same work. Keep job descriptions, payroll records, and performance notes. See the salary vs. dividends trade-off analysis for a fuller comparison of how each option affects your overall tax position.
Dividends on excluded shares: If your spouse or adult child meets the 10% ownership and voting thresholds and the corporation passes the 90% gross income test, dividends on those shares are excluded. Restructuring share classes to meet these thresholds is a common and legitimate planning step, but it requires a formal share reorganisation and legal documentation.
Capital contributions and formal loans: A family member who contributes capital at arm’s length and receives a return on that capital has a stronger reasonable-return argument. Document the contribution with a formal loan agreement or subscription agreement, and use market-rate interest on any loans. For guidance on how much capital a small business can raise through borrowing, LenderReady’s small-business borrowing overview provides useful context on structuring debt.
Dividends on paying dividends to your spouse: Review the specific guidance on paying dividends to a spouse before proceeding. The spousal context has its own nuances under the reasonable return and excluded shares tests.

What consistently fails:

Post-hoc justifications assembled after a CRA audit letter arrives. Retrospective timesheets and backdated resolutions rarely satisfy CRA reviewers.
Paying dividends to a family member who has no documented role, no capital at risk, and no historical involvement in the business, then arguing reasonable return based on vague “contributions.”
Assuming that because a family member holds shares, the income is automatically excluded. Share ownership alone does not trigger any exclusion.

When restructuring share classes or setting up formal buy-ins, involve a tax lawyer alongside your CPA. The tax implications of a share reorganisation can be significant, and the structure needs to hold up to scrutiny from the date it is implemented.

Audit risks, CRA red flags, and your documentation checklist

CRA’s review of TOSI positions focuses heavily on whether the taxpayer can prove, with records created at the time, that an exclusion was genuinely met. Practitioner analysis from Mondaq identifies the lack of contemporaneous documentation as the single most common and critical deficiency found in TOSI audits. Retrospective evidence rarely convinces CRA.

Common CRA red flags:

Sudden or large dividend payments to family members with no prior history of involvement
Dividends paid to spouses or adult children who have no documented role in the business
Inconsistent payment patterns (large dividends in high-income years, nothing in low-income years)
Share structures that appear designed solely to shift income rather than reflect genuine economic arrangements
Absence of shareholder agreements, board resolutions, or formal documentation of capital contributions

Documentation checklist:

Timesheets or work logs showing hours and tasks (weekly or monthly, dated at the time)
Board or shareholder resolutions authorising dividend payments and referencing the basis for the amount
Formal shareholder agreements specifying share classes, voting rights, and economic entitlements
Capital contribution records: bank transfers, subscription agreements, or loan agreements
Payroll records if salary is paid (T4 slips, payroll deductions, ROE)
Invoices, client lists, or project records showing the family member’s client-facing or operational work
Performance metrics or email correspondence demonstrating active involvement
Copies of personal guarantees or other risk-bearing arrangements

Retain all records for at least six years from the end of the tax year to which they relate. Electronic records are acceptable provided they are legible and complete.

Pro Tip: Document the rationale for every family dividend payment in a dated board resolution or memo before the payment is made. Include the specific exclusion you are relying on, the evidence supporting it, and the amount. A one-page memo written the day before the dividend is declared is worth more in a CRA audit than a binder assembled two years later.

What to do right now if you are unsure whether TOSI applies

A short action checklist you can run today:

Identify all recipients: List every family member who received or will receive dividends, partnership income, trust distributions, or interest from your private corporation.
Map payments to business income: Confirm whether the income is derived from a related business. If the corporation earns only passive investment income, TOSI may not apply; if it earns active business income, it likely does.
Check age and ownership: Apply the age-bracket table above to each recipient. For those 25 and over, work through the excluded shares and excluded business tests.
Assemble supporting records: Pull timesheets, resolutions, and capital contribution records now. Gaps are easier to address before a payment than after.
Pause discretionary dividends: If you cannot confirm an exclusion applies with current documentation, hold off on the next dividend payment until you can.
Consult a CPA or tax lawyer: Bring your shareholder register, recent financial statements, any existing shareholder agreements, and a summary of each family member’s role and capital contributions. A personal tax worksheet can help you model the tax impact of different payment scenarios before your meeting.

How TOSI affects the overall family tax picture

TOSI does not exist in isolation. When it applies, it interacts with several other parts of the tax return in ways that can compound the cost.

The dividend tax credit, which normally reduces the tax on eligible or non-eligible dividends, is available only to the extent of the recipient’s regular tax otherwise payable. It cannot reduce the TOSI amount itself. This means a family member with little other income, who might otherwise pay minimal tax on a dividend, can end up with a significant tax bill purely because of TOSI.

The basic personal amount credit can offset a portion of TOSI, but most other personal credits (tuition, medical, charitable donations) cannot. This limits the usual tax-planning tools available to lower-income family members.

TOSI also affects the family’s overall marginal rate planning. One of the core reasons families distribute income to lower-bracket members is to access lower marginal rates. TOSI eliminates that benefit for split income, effectively taxing it at the highest federal rate regardless of the recipient’s other income. For Saskatchewan residents, the combined federal and provincial top marginal rate applies to TOSI amounts, making non-compliant distributions significantly more expensive than anticipated.

Finally, TOSI income cannot be sheltered by RRSP contribution room. The recipient cannot deduct an RRSP contribution against TOSI tax, since TOSI is a separate additional tax, not part of the regular income calculation.

Penalties and interest for TOSI non-compliance

Failing to report split income correctly carries the same penalty and interest regime as other federal tax non-compliance, with a few points worth noting specifically.

If TOSI is assessed on audit, CRA will reassess the recipient’s T1 return to add the tax at the top marginal rate. Interest accrues on the unpaid amount from the original filing due date (generally April 30 of the following year) at the prescribed rate, compounded daily. For amounts that have been outstanding for several years before an audit, the interest alone can be substantial.

The gross negligence penalty under section 163(2) of the Income Tax Act can apply if CRA determines the taxpayer knowingly or under circumstances amounting to gross negligence failed to report the split income. It is not automatic, but CRA is more likely to apply it where the taxpayer had access to professional advice and the income-splitting arrangement was clearly structured to avoid TOSI.

The late-filing penalty under section 162(1) applies if the T1 return is filed late and TOSI is owing.

Voluntary disclosure through CRA’s Voluntary Disclosures Programme can reduce or eliminate penalties (though not interest) for taxpayers who come forward before CRA contacts them. If you believe prior years’ returns may have incorrectly excluded split income, speaking with a tax professional about a voluntary disclosure is worth considering before CRA initiates a review.

How TOSI interacts with provincial tax rules in Saskatchewan

TOSI is a federal tax, but it has direct provincial consequences. Saskatchewan levies its own provincial income tax on the same income base, and the provincial tax on split income is calculated separately from the federal TOSI amount.

For Saskatchewan residents, the provincial split income tax is reported using Form T2203 when the individual has income from multiple jurisdictions, or directly on the Saskatchewan provincial schedule of the T1 return for single-province filers. The provincial tax rate applied to split income is Saskatchewan’s top marginal provincial rate, which applies to the same income that attracted federal TOSI.

Saskatchewan does not have its own separate “TOSI” legislation; the province piggybacks on the federal definition of split income and the federal exclusions. This means that if an exclusion applies federally (excluded business, excluded shares, or reasonable return), it also applies provincially. Conversely, if federal TOSI applies, provincial tax on that amount follows automatically.

One practical implication for Saskatchewan farm families and agribusiness owners: if your corporation earns income from both farming operations and passive investments, the classification of income as active business income versus property income affects both the federal TOSI analysis and the Saskatchewan provincial tax calculation. The RSM Canada practical approach paper highlights that this distinction requires a careful facts-and-circumstances review, not a formulaic answer.

TOSI in estate planning and for deceased individuals

Estate planning for family businesses in Saskatchewan needs to account for TOSI at two distinct points: during the owner’s lifetime when shares are transferred or gifted, and at death when the estate is administered.

During lifetime transfers:

Transferring shares to adult children or a family trust can trigger TOSI if the transferred shares do not meet the excluded shares criteria or if the recipient is not actively engaged in the business. Shares transferred to a family trust are particularly complex: trust distributions to adult beneficiaries are subject to TOSI unless the beneficiary independently meets an exclusion test.

At death:

When a business owner dies, the deemed disposition rules under section 70 of the Income Tax Act treat the owner as having sold all assets at fair market value immediately before death. Capital gains arising from this deemed disposition are not split income and are not subject to TOSI. However, if shares are distributed from the estate to beneficiaries who then receive dividends from the corporation, those dividends can be subject to TOSI in the beneficiaries’ hands if no exclusion applies.

The spousal rollover under section 70(6) allows shares to pass to a surviving spouse at cost, deferring the capital gain. This is a standard estate-planning tool, but it does not resolve the TOSI exposure that arises when the surviving spouse later receives dividends from the corporation. The spouse still needs to meet an exclusion test (excluded shares or reasonable return) for those future dividends to avoid TOSI.

Executors and estate trustees should review the TOSI status of any corporate shares in the estate and flag potential exposure to beneficiaries before distributions are made. Documenting the basis for any exclusion claimed in the estate’s terminal return or in the beneficiary’s T1 is as important in an estate context as it is during the owner’s lifetime.

Why documentation is the real TOSI strategy

The TOSI rules are genuinely complex, but the single variable that determines whether a family business survives a CRA review is almost always documentation, not the structure itself. Many families have legitimate exclusions available to them and lose them entirely because no one wrote anything down at the time.

At T-Ledgers, we see this pattern repeatedly: a well-structured arrangement that should qualify under the excluded business or reasonable return test falls apart because the records were assembled after the fact. CRA reviewers are experienced at spotting retrospective documentation, and they discount it heavily. The families who fare best are those who treat each dividend payment as a decision that needs a paper trail, not a routine transaction.

T-Ledgers’ virtual CFO and business tax filing services are built around exactly this kind of proactive planning. Our CPAs help you identify your TOSI exposure before payments are made, build the documentation framework that supports your exclusion, and handle the reporting correctly so there are no surprises at filing time.

How T-Ledgers can help you manage TOSI risk

TOSI exposure is one of the most common and costly surprises for Saskatchewan family businesses, and it is almost entirely preventable with the right planning in place before dividends are declared.

T-Ledgers offers flat-rate virtual CFO services that include a TOSI risk review as part of your annual tax planning. There are no hourly billing surprises: you know the cost upfront, and the work covers identifying which family members are specified individuals, confirming which exclusions apply, building the documentation checklist specific to your situation, and completing Form T1206 and Line 40424 correctly at filing time. When you reach out, bring your shareholder register, the most recent corporate financial statements, any existing shareholder agreements, and a brief note on each family member’s role and capital contributions. That is enough to get a clear picture of your exposure and a plan to address it.

Sources

FAQ

What are the TOSI rules in Canada?

TOSI (Tax on Split Income) taxes certain income paid to family members connected to a private corporation at the top federal marginal rate, under section 120.4 of the Income Tax Act. The rules apply to dividends, certain capital gains, and related-party income, and have been in their current expanded form since the 2018 tax year.

How do I know if TOSI applies to me?

TOSI applies if you are a Canadian resident who received income from a “related business” in which a family member is actively engaged or holds a significant interest, and you do not qualify for an exclusion such as excluded business, excluded shares, or reasonable return. Your age and the nature of your involvement in the business determine which exclusions are available to you.

How can you legally avoid TOSI?

Each exclusion requires contemporaneous documentation to withstand CRA review.

What qualifies as low income in Saskatchewan for TOSI purposes?

TOSI does not use a “low income” threshold; it applies based on the relationship between the recipient and the business, not the recipient’s income level. The tax is calculated at the top marginal rate regardless of the recipient’s other income, so even a family member with no other income pays TOSI at the highest rate on split income amounts that do not qualify for an exclusion.

What is the difference between TOSI and the section 67 salary reasonableness test?

TOSI applies to dividends, capital gains, and certain other income from private corporations paid to connected family members. Section 67 applies to salary and wages paid to family members, requiring that the amount be reasonable for the services actually performed. Salary is not split income and is not subject to TOSI, but CRA will still review whether the salary amount is reasonable compared to what an arm’s-length employee would earn for the same work.

This article provides general information about Canadian tax rules and is not a substitute for professional tax advice. Confirm current rules with the Canada Revenue Agency or a qualified tax professional before making decisions about family income distributions.