Form T1206: Understand the Onus of Proof Under TOSI

Evelyn Jacks

TOSI, a most controversial provision introduced on July 17, 2017 is now in its second reporting year. As many companies are  preparing T5 slips, dividends distributed from certain professional corporations must be properly reported for non-active members of the family. Tax specialists will want to discuss where the onus of proof lies for proper reporting and brush up on the complex rules and their impact using tax form T120.

Starting in 2018, certain types of income received from private corporations in the hands of individuals will be subject to TOSI.  All professionals should review form T1206, previously used only for the reporting of “kiddie tax.”  It is now used by all resident Canadian taxfilers who receive distributions of certain income sources – usually dividends – from certain private corporations. These are known as non-eligible dividends, but dividend tax treatment will elude the recipients subject to TOSI, as described below.

Individuals potentially subject to Tax on Split Income on the 2019 tax return include those who have received dividends and other income from a privately held corporation.  To avoid the inclusion of income on Form T1206 at top marginal rates of tax, the individual must be prepared to show that they have earned a “reasonable return” from the private corporation by meeting the “Reasonableness Criteria” administered by CRA. 

What’s particularly important to note here is that the onus of proof has, in fact, been transferred to the taxpayer who receives the split income.  If it’s not properly reported it’s that recipient who faces potential tax reassessments, interest and penalties for gross negligence depending on the circumstances. 

In general, “TOSI”, will apply if the recipient of the income is a “specified individual” who is in receipt of “split income” from a “source individual” who has a sufficient connection to a “related business”.   This will be Greek to most clients, but it’s important for tax specialists to explain the rules in order to empower legitimate planning around them.

The definition of Split Income, includes the following amounts received by a specified individual from any “related business” carried on by a “source individual”:

  • Taxable dividends from a private corporation
  • Shareholder benefits
  • Partnership, corporation, or trust income earned by a source individual in any related business or a source individual who has an interest – directly or indirectly – in any such organizations.
  • Rental income from a property owned by a source individual
  • Income from the indebtedness in a corporation, partnership, or trust. (Note that debt obligations from mutual fund corporations or corporation shares of a class of the capital stock listed on a designated stock exchange are excluded.)
  • Income or gains from the disposition of any of the properties above, including a taxable capital gain or a profit from the disposition of property after 2017.

Those income sources subject to TOSI amount to an expensive distribution. There is no personal amount nor graduated tax rates with respect to the split income.  TOSI amounts are subject to tax at the highest marginal tax rate. 

Avoiding TOSI.  Tax on Split Income (TOSI) applies to all adults unless they fall into a specific exclusion, which contain three broad categories:

  • Family members, age 25 to 64, who own shares that represent at least 10% of the voting shares and value of the company
  • Family members who are over age 17 who are “actively engaged” in the business; that if they averaged at least 20 hours per week working in the business in the current year or at least five previous years
  • Spouses of business owners who are age 65 or older

The following are additional circumstances in which TOSI can be avoided:

  • For anyone under 25 years old, income or gains from the disposition of property resulting from the death of a parent exempt.These family members TOSI if they are entitled to the Disability Tax Credit or are a full-time student in a post-secondary institution and received the money from someone other than a parent.
  • Property transferred, at any age, due to a separation agreement or judgement due to marriage or common-law relationship breakdowns.
  • Taxable capital gains resulting from deemed disposition on death of a taxpayer.
  • Taxable capital gains resulting from dispositions of qualified farm or fishing enterprises or qualifying small business corporation shares.  
  • Income received by a spouse or common-law partner from the active spouse who has reached age 65, or in cases where the amounts were received as a result of the source spouse’s death.

Note that for the purposes of these exclusions, related individuals do not include aunts, uncles, nieces, or nephews.

A tax specialist can assist in determining whether a privately held corporation will be required to observe these rules. They are primarily targeted at professional service businesses, but to be sure,  speak to a MFA™-Business Services Specialist.

Additional educational resource:  Corporate Income Tax Fundamentals certificate course, or pursue your full designation to become an MFA™- Business Services Specialist.