Principal Issues: Whether excluded business test will apply when there has been a change in business activities and the succeeding business operations are not the same as the former?
Position: General comments provided but in this case no.
Reasons: Legislation and previous positions.
2019 CTF Annual Conference
CRA Roundtable
Question 8: TOSI – Excluded Business
The definition of an excluded amount in subsection 120.4(1) of the Act allows an exemption from the application of tax on split income (TOSI) provided the dividend be derived directly or indirectly from an excluded business of the individual for the year. Pursuant to the definition in subsection 120.4(1), “excluded business” means a business of the specified individual if the specified individual is actively engaged on a regular, continuous and substantial basis in the activities of the business.
ABC Co. is owned 100% by a family trust, of which Mr. and Mrs. A are both beneficiaries. ABC Co. historically carried on a trucking business from incorporation in 1990, and each of Mr. and Mrs. A were actively engaged on a regular, continuous and substantial basis throughout all of the years of its operations.
The business operations were sold in 2018, and the proceeds have been invested inside ABC Co. ABC Co. now carries on an investment business. Mrs. A is active in the investment business but Mr. A is not.
As Mr. and Mrs. A, who are both over 24 years old, do not own shares of ABC Co. directly, they will not meet the “excluded share” exception.
Will the excluded business exception apply to Mr. A, given that he had previously been actively engaged on a regular, continuous and substantial basis in the trucking business carried on by ABC Co. for more than five years, notwithstanding that the trucking business has ceased and the proceeds from the sale of its assets have been invested in ABC Co.’s investment business?
CRA Response
Under the TOSI rules in section 120.4 of the Act, TOSI will apply to tax the “split income” of a “specified individual” at the highest marginal rate unless the amount is an “excluded amount”.
In the above scenario, ABC Co.’s trucking business operations have completely ceased and its assets sold and reinvested (presumably along with the historical retained earnings) in an investment business carried on by ABC Co. The investment business is a “related business” in respect of Mr. A (a specified individual) for a taxation year since Mrs. A (a “source individual” in respect of Mr. A) is actively engaged on a regular basis in the activities of ABC Co. related to earning income from the business.
Where the family trust makes a subsection 104(19) designation in a particular taxation year of the trust in respect of all or a portion of a taxable dividend it received from ABC Co. (for a taxation year of ABC Co. after its trucking business ceased), such amount would be deemed, inter alia, to be a taxable dividend received on a share by Mr. A and/or Mrs. A, as the case may be, in his/her taxation year in which the family trust’s particular taxation year ends. Such income would be “split income” of Mr. A unless an excluded amount exception applies.
The investment business currently being carried on by ABC Co. is not the same business as the trucking business formerly carried on by it. Any taxable dividend that Mr. A is deemed to receive is considered to be derived directly or indirectly from such investment business. If Mr. A is not actively engaged in the investment business during the particular taxation year or in any five prior taxation years, the amount will not be an excluded amount under subparagraph (e)(ii) of that definition because such amount will not be income derived directly or indirectly from an “excluded business” of Mr. A for the year. Consequently, the taxable dividend designated by the trust in respect of Mr. A pursuant to subsection 104(19) will be split income subject to TOSI unless another excluded amount exception applies.
Further information would need to be provided to determine whether such income received would represent a “reasonable return” in respect of Mr. A or whether another excluded amount exception could apply.
Karri Lea Estabrooks
2019-082441
December 3, 2019