As April 30th is approaching, many people are thinking of tax planning options in order to reduce the amount of tax that they must pay. A common method of tax planning is income splitting; this method is done by the high-income family member (transferor) diverting their investment income to low-income family members (transferee) by gifting or loaning money or property. Income splitting was commonly done with corporations but the recent expansion of the Tax on Split Income (TOSI) severely curtailed that planning. As such, we are exploring alternatives to the use of corporations. However, without proper planning, the income being transferred may be subject to income attribution rules or TOSI in the Income Tax Act.
The income attribution rules in the Act will have any income earned on property gifted or loaned by the transferor will be taxable for the transferor rather than the transferee. Whether the income attribution rules apply in the situation depends on the type of income and the relationship between the transferor and the transferee. For example, if you gift cash to your spouse, the capital gains and investment income may be attributed back to transferor but if you gift the cash to a minor only the investment income, and not the capital gains, may be attributed back to the transferor.
If the cash in the example above is loaned rather than gifted, there is no attribution no matter who it is to if interest is charged at the Canada Revenue Agency’s prescribed rate (currently 2%) and the interest is actually paid. These interest payments will need to be paid by 30 days after year end (January 30th) and included in the transferor’s income.
If property other than cash, such as securities, is transferred, the above rules are still true but with the additional requirement for a spouse to elect out of the normal tax-free rollover at cost, so a gain is recognized on the transfer.
A straightforward gift or loan means the recipient has direct ownership over the investments that are made which may not be desirable if they are a minor or not responsible with money. Furthermore, if you have multiple family members, an income splitting plan must be set up for each of them. A family trust can be used to provide flexibility to an income splitting strategy and some control over the investment activity. Essentially, one family trust is created that has all the intended recipients as beneficiaries and the investment loan is made to the trust. The trustees make the investment decisions and decide which beneficiary will receive the trust’s income.
There is new tax legislation related to income attribution rules called Tax on Split Income (“TOSI”). Under TOSI if a person is receiving income, other than employment income, from a “related business” the income will be taxed at the highest rate unless an exclusion applies. This can apply to income allocated from a trust if it is carrying on a business or is earning rental income.
If you have any questions relating to this matter, contact your tax professionals at Wilkinson & Co. LLP
This publication is a general discussion of certain tax matters and should not be relied upon as professional advice. If you require tax advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.