New Income Splitting Rules for Canadian Corporations (2018)
Allan Madan, CA
Do you own a Canadian private corporation and want to pay dividends to your family members? The new income splitting rules introduced by the federal government make it more difficult to do so. Keep reading to find out what you need to know about these new rules.
The Old Rules
Prior to 2018, a dividend could be paid without restrictions to family members (18 or older) of the owner of a Canadian private corporation. By splitting the company’s income among several family members, the family could reduce the overall tax it paid to the Canada Revenue Agency.
The New Rules
As of 2018, dividends paid to family members of the owner of a Canadian private corporation will be taxed at the highest marginal tax rate for dividends, which could be as high as 40% in some provinces. As a result, there is no longer a tax benefit from dividend sprinkling.
For example, assume that ABC Inc., a Canadian private corporation, paid $100,000 of dividends to the owner’s adult son, who doesn’t work in the business. The annual dividend is the son’s only source of income.
Under the old rules, the son would only pay $17,000 of income tax on the dividend received. Under the new rules, the son will pay $40,000 of income tax on the dividend received.
As you can see, the new rules on dividend sprinkling have eliminated the tax benefit from paying dividends to family members. However, there are certain exceptions to the new rules.
1. Non-Service Businesses
Businesses that derive more than 90% of their income by selling anything other than services are exempt from the new dividend rules so long as:
a) The family member receiving the dividends is at least 25 years of age and owns at least 10% of the voting shares and value of the family business.
b) The business is not a professional corporation. Professional corporations are corporations owned by doctors, lawyers, accountants, and engineers.
What exactly is a non-service business? Examples of non-service businesses include retailers of goods, wholesalers, manufacturing businesses, and import/export businesses.
Let’s look at an example. Al Bundy, a Canadian Resident, is the owner of Ugly Shoes Inc., a Canadian private corporation. Ugly Shoes Inc. sells designer shoes at the local mall. Al’s daughter, Kelly, is 25 years old, and she owns 10% of her father’s company. Ugly Shoes Inc. paid a dividend of $50,000 to Kelly on May 1, 2018.
In this scenario, Kelly is not subject to the new rules, which tax dividends at a high rate. This is because she is 25 years of age, she owns at least 10% of her father’s company, and the company is a non-service business. As such, Kelly will pay income tax at regular tax rates on the dividend she received.
2. Family Member Works in the Business
The second exception to the new income splitting rules on dividends has to do with family members working in the family business. A family member can receive dividends from a Canadian private corporation if the following conditions are met:
a) The family member worked in the business for at least 20 hours per week continuously in the current tax year or for at least 20 hours per week for 5 prior years; and
b) The amount of the dividend paid is reasonable based on the work performed.
Let’s look at an example. Bud Bundy, who is Al’s 19-year-old son, works 20 hours per week at Ugly Shoes Inc. as Stock Room Clerk. Bud’s job is to keep the stock room neat and tidy. Stock Room Clerk’s get paid on average $1,200 per month, for part-time work. Bud receives a monthly dividend from Ugly Shoes Inc. for $1,200 per month.
In this scenario, Bud would be exempt from the new dividend rules, since he works at least 20 hours per week in the family business and the dividends paid to him are reasonable.
3. Family Member Invests in the Business
Family members who are at least 25 years of age and who receive reasonable dividends based on the financial investment that they make in the family business are exempt from the new dividend rules. The reasonability of dividends paid is determined by looking at these factors:
• The amount of financial investment made
• The risk assumed
• The work performed
• Other relevant factors
Let’s look at an example. Kelly Bundy, a Canadian Resident, decides to sell high-end woman’s shoes online. She incorporates a private Canadian company called KB Inc. Kelly’s business needs start-up funds, and so her mom, Peggy, invests $100,000 in Kelly’s company. In exchange for her investment, Peggy receives a 12% dividend each year, amounting to $12,000/year. Before asking her Mom for help, Kelly approached potential private investors who also wanted a 12% return on investment.
In this scenario, Peggy is exempt from the new dividend rules, which impose the highest tax rate on dividends received by a family member. This is because Peggy is at least 25 years old, she made a substantial financial investment, and she is receiving a market rate of return.
Disclaimer
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.
ABOUT THE AUTHOR
ALLAN MADAN
CA.CPA.CGA
Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.
.png)
Can you please share a link to canada.ca website that talks about the new rules?
Hi Pramit, see this link from CRA’s website for further details:
https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/income-sprinkling/guidance-split-income-rules-adults.html
Nice information, Thanks
Can you please clarify bit more about following Non-Service Businesses stuff.
**********************************************************
canada.ca website says Excluded Shares: shares of a corporation owned by an individual are excluded shares where: less than 90% of the corporation’s business income was from the provision of services and the corporation is not a professional corporation;
and your website says: Non-Service Businesses: Businesses that derive more than 90% of their income by selling anything other than services are exempt from the new dividend rules.
**********************************************************
Hi Sam,
You are correct. If less than 90% of the corporation’s income was from services, then the shares are excluded, and so TOSI will not apply to the dividends paid on those shares. For example, if a company’s revenues are 50% from the sale of goods and 50% from the provision of services, then the shares will be excluded shares. This is because less than 90% of the corporation’s income was from services.
Do the new rules change anything for the case where dividends are paid out to the corporate owner (not family members)?
Hi Gill,
The new rules do not impact dividends paid out to the owner running the business.
Will dividend received by non-voting shareholders (adult children over age 25) of a private corporation that owns 1 rental property in Toronto be subject to the highest tax rate under the new rule?
Hi Marg,
Yes, dividends paid to adult children from a Canadian Private Corporation will be subject to the highest personal tax rate under the new rules, unless the adult children (25 or older) have made a substantial investment in the business, and the amount of the dividends paid are reasonable in relation to the amount invested.
I read an article that said that if you are a senior then you can still income split dividends with your spouse.Is that the case?
Hi Randy,
Yes, if you are 65 or older and own a Canadian private corporation, you can pay dividends to a spouse who is also a shareholder of the corporation without restrictions.
Iam an independent IT consultant who has incorporated my Business. Along with me, my spouse is marked as director in my business. Will sending dividend to her is taxable in a new rate or old rate..?
Hi Shiva,
A director cannot receive a dividend. Only shareholders can receive dividends. Dividends paid by a Canadian corporation on or after January 1, 2018 are subject to the new rules.
Are dividends paid to a spouse who owns non-voting shares in a non professional corporation considered excluded if the spouse is less than 60 years old but the other spouse is older than 65?
Yes, because one spouse (whom I’m assuming is the principal business owner / operator) is retired (65 or older) and so dividends paid to the other spouse (non-voting shareholder) are excluded from TOSI.
Hi, I understand the above but I see nowhere explained what happens with salary. Supposed I don-t want to pay a dividend but rather a salary to my spouse. What are the rules in that case?
Hi Waiter,
The new income splitting rules do not impact salaries/wages paid to a family member. The salary/wages paid to a family member must be reasonable based on the type of work, education of the family member and difficulty of the job.
Hi Allan,
Is it right to say if dentist pays dividend to his wife irrespective to the fact that the share she owns has voting right or not would attract TOSI and would be taxed at higher rate. reason : Dentist has a professional corporation.
Hi Nayay,
Yes, the dividend paid to your spouse, in this case, will attract TOSI, unless the amount of the dividends paid to your wife are reasonable based on the work she performs for the business, and so long as she is working at least 20 / hours per week on average in the business.
Amazing article. Way better examples then I have seen elsewhere.
To make it all about me.
I am a truck driver and have a corporation. All my contract work get pays into the corporation. And I pay myself a salary. But with the new rules can I pay my wife a dividend. She is listed as 50% owner. She Does only 1 hour of paper work a month and there was basically no startup capital put in to this corporation.
Can the corporation pay her anything?
Part 2.
We own a 2nd Ontario # corporation that rents out generators and other equipment to the trucking industry but also some other customers (painters , carpenters)
She is running all the sales and rental work here but this is an even smaller side business/corporation for us and is about 1-2 hours of work a month top.
So far the money has just been accumulating inside the corporation.
Can I pay her from this one?
Thanks in advance.
Hi Moe,
You can pay your wife a dividend, so long as:
1. She is a shareholder; and
2. The dividends paid to her are reasonable based on the work she is performing and the number of hours she is working.
For example, if your wife is providing administrative support for 2 hours per week, and she is a shareholder, then a reasonable dividend amount would be $50 per week (2 hours x $25 / hour).
Remember to keep timesheets so that your wife can prove the # of hours worked for each company.
Hi,
Great info on your web site. thanks for sharing.
Could you please tell me when professional corporation has no longer active income (the doctor retired) but there are assets inside the Corp. Can he pay normal non eligible dividend to himself and his kids?
Thanks
Alex
Hi Alex,
The new income splitting rules generally prohibit dividends paid to family members that are not actively involved in the business. However, you (and your wife if she is a shareholder) can receive eligible dividends as you both are retired. Eligible dividends are paid from the corporation’s GRIP balance.
I’d like to know if the income splitting rules apply in my case. I reside in Canada and own 1% of a family business, my parents and siblings own 49%, and aunts uncles and cousins own the other 50%. The business is located in the USA and all of the family members (except me) are also in the USA. I’m only questioning this based on location of business; the income splitting rules would otherwise apply.
Hi Pine,
The Canadian income splitting rules do not apply to US companies.