Personal taxation for families that operate a business through a Canadian Controlled Private Corporation has drastically changed since the announcement of the new Tax on Split Income (TOSI) rules for adults in July of 2017. Prior to the changes, a shareholder could receive unlimited dividends. However, under the new rules, it is very difficult to pay dividends to family members and have those dividends taxed at their marginal rates, unless they are working full-time in the business. In developing the legislation, the Department of Finance recognized that a shareholder may contribute to the profit of a business even though they may not be working full-time in the business and considered this in the various TOSI exceptions. One such exception is when a shareholder is actively engaged on a regular, continuous and substantial basis in the business in the current year or any five preceding years, either on a factual basis or by meeting a threshold of an average of 20 hours per week for the period of the year the business operates.
We are often asked by clients, “Can I meet this test and how do I prove it?” Determining if a person satisfies the test of being actively engaged in the business is based on the facts and circumstances of the situation. If a shareholder is clearly substantially contributing to the business, this test may be fairly easily satisfied. Because this test is very subjective, the legislation also provides a “bright line test” of 20-hour average per week. Keep in mind that under this “excluded business” exception, if relying on the hours per week threshold, the individual does not need to work 20 hours every week of the year, however, they would need to meet the average of 20 hours over the operating period. For example, a person working full-time for a number of weeks and reduced hours or not at all during other weeks may still meet this average 20- hour threshold.
It is possible and quite likely that the CRA will begin to audit corporations and shareholders to determine if the level of activity and involvement in a business supports the payment of dividends that are not subject to TOSI. In that regard, where dividends are being paid to family members working in the business, we are advising clients to maintain records to support the hours worked including the following:
Timesheets and work schedules
Payroll records showing hours per period
Evidence of the work performed by that individual such as sign-off and dating on completion of tasks
It is also advisable that the shareholder ensure other staff are familiar with the nature of the role and the tasks performed by the individual as they may also be interviewed or asked about the shareholder’s involvement as part of the audit. It is also recommended that the shareholder have an employment contract including a full job description and list of duties to be performed. The CRA has acknowledged that where the shareholder’s work history over five prior years is being considered, and supporting documentations may no longer be available, they intend to be reasonable in evaluating such situations. Any information available related to the history of the business and the extent and nature of the person’s involvement will be considered. Therefore compiling these details early will hopefully avoid unwanted reassessments should records become old and unavailable.
For further information on the topic, please don't hesitate to contact your trusted LCA advisor.