Updated Proposed Rules on Income Sprikling

On December 13, 2017, the Government released its updated proposed rules on Income Sprinkling (also known as Income Splitting). These rules were first proposed on July 18, 2017, effective in 2018, and operated in a manner that would tax the recipient of “split income” (e.g. dividends from a family-owned corporation that carries on a business in which a related individual is active) at the highest marginal tax rate if the income was not considered “reasonable”. Then on October 16, 2017, the Government announced that it would update these rules to reduce their complexity and the associated compliance burden.

The Effects of Income Sprinkling

Generally, Income Sprinkling refers to the transfer of income between family members to effect a lower overall tax rate compared to if the income was earned directly by one family member (who would typically be in a higher tax bracket). The Government has stated that these updated proposed rules on Income Sprinkling should not affect family members who make meaningful contributions to a family business.

The updated rules now include several automatic “bright-line” tests that should exclude certain family members from their application. These exclusions are summarized below:

• Adults aged 18 or over who have made a substantial labor contribution (generally an average of at least 20 hours per week) to the business during the year, or during any five previous years.

• Adults between the ages of 18 and 24 may receive a “safe harbour capital return” determined by formula, or a “reasonable return” based on contributions of “arm’s length capital” that is not subject to the Income Sprinkling rules.

• Adults aged 25 or over who directly own shares having 10% or more of the votes and value of a corporation that meets the following criteria:

• the corporation earns less than 90% of its income from the provision of services;

• the corporation is not a professional corporation (e.g. accountant, dentist, doctor, lawyer, etc.); and

• the corporation does not derive income from another business in which a related person is active or has a 10% or more ownership interest.

Individuals seeking to rely on this exclusion will be granted some transitional relief in that they will have until the end of 2018 to meet the 10% ownership requirement.

Adults aged 25 or over are also exempt from the new rules in regards to a “reasonable return” that they receive based on work performed, property contributed, risks assumed, historical payments and any other relevant factors.

• The business owner’s spouse, provided that the owner meaningfully contributed to the business and is aged 65 or over. The Government has stated that this new approach to the Income Sprinkling rules will be better aligned with the existing pension income splitting rules.

• Capital gains realized on death or from the disposition of qualified small business corporation shares or qualified farm or fishing property by individuals aged 18 or older

• Individuals who receive income or capital gains from property that is acquired as a result of a breakdown of marriage or common-law partnership.

Canada Revenue Agency has released guidance on the updated Income Sprinkling rules. Please find their Frequently asked questions – Income sprinkling and Guidance on the application of the split income rules for adults documents by clicking here.

Also of note, the updated rules no longer apply to second-generation income (i.e. income earned on split income) nor consider aunts, uncles, nieces and nephews as related individuals.