A recent tax change that has gotten a lot
of attention is the tax on split income, or “TOSI”. Through design or inadvertently, many trusts will
be affected by these rules. Many family
trusts were set up at least partially to split income to family members. Even when income splitting is not an express
purpose of the trust, where a trust owns property that earns money from the
work or investment of a person (“source individual”) who is related to a
beneficiary, there is a risk TOSI may apply.
Things
Trustees and their advisors should know about TOSI
1. TOSI doesn’t just apply to
dividends
While dividends have gotten the most
press, TOSI may apply to any income from a “related business”.
A related business is any business,
whether operated personally or through a partnership, corporation or trust,
where a source individual at any time during the year was “actively engaged on
a regular basis in the activities” or in which he or she had a qualifying
interest (for a corporation this is 10% or more). TOSI may apply to any dividends, shareholder
benefits, capital gains, or interest derived from a related business.
This means trustees need to look
carefully at any source of income and ensure it is not caught under the TOSI
rules. I recommend starting with the
assumption that TOSI applies to any income, unless you can find a reason why it
should be excluded.
2. Beneficiaries of trusts
cannot own “excluded shares” through a trust
One of the main exclusions to the TOSI
rules is if the recipient owns “excluded shares”. Shares are excluded shares when an individual
owns at least 10% of the shares of a corporation which meet specific criteria.
Income earned on excluded shares, or gains earned on disposing of excluded
shares, are not caught by TOSI.
Unfortunately, even if a trust owns
shares that would otherwise be excluded shares, income allocated through the
trust to a beneficiary on those shares owned by the trust will not qualify as
shares “owned by the specified individual”, (and therefore not “excluded
shares”) since the beneficiary and not the trust would be the specified
individual.
This is a significant disadvantage of
owning what otherwise might qualify as excluded shares through a family
trust. In some cases, it may make sense
to distribute shares owned by a trust to a beneficiary so they do qualify as
excluded shares for that particular beneficiary.
3. Some exclusions from TOSI
will still apply to allocations from trusts
There are, however, exclusions that will
still apply to payments through a trust.
While capital gains from a related
business are now generally caught by TOSI, capital gains that qualify for the
capital gains exemption are specifically excluded, including for allocations
from trusts.
A second exemption is that if the income
derives from a business which is an “excluded business” for the beneficiary, then
it will not be caught by TOSI.
A business will be an “excluded business”
if the beneficiary was actively engaged on a regular, continuous and
substantial basis in the activities of the business in either the taxation year
or any prior five taxation years.
While “actively engaged” is not defined,
if the beneficiary works at least an average of 20 hours per week in the
business (while the business operates), the beneficiary will be deemed to be
actively engaged.
Recent CRA publications and responses to
questions at conferences have also suggested that passive investment income
earned on the investment of income from a related business, is not itself necessarily
income from that related business.
This suggests that, with the right
structure, investment income earned on income itself caught by TOSI could be an
excluded amount.
Conclusion
The new TOSI rules will make things more
complicated for trustees and their advisors when it comes to allocating income
to beneficiaries. Existing trusts should
be re-examined to determine whether they should be restructured or their operations
changed. Potential settlors, trustees
and their advisors will need to more carefully consider whether setting up a
new trust is the best option.
However, trusts will continue to be used
for non-tax reasons where it is advisable to separate legal and beneficial
ownership and, depending on individual circumstances, trust will continue to
make sense in certain tax plans.
