Canadian Tax Planning Rules for Family-Owned Businesses
As we get closer to the April 30th deadline, personal taxes are on everyone’s mind.
Whether or not it’s also year-end for your corporation, you can save significant sums of money by knowing the rules and avoiding the common pitfalls of filing taxes as a family-run company.
The Tax on Split Income (TOSI) and Attribution Rules
The Tax on Split Income (TOSI) rules were originally created to prevent Canadian business owners from splitting profits with minor children that are not really involved in their company.
These “kiddie rules” stipulate that any income earned by minor children is taxed at the top marginal rate, thus eliminating the benefit of such tax planning structures.
Over the years, the CRA has eliminated other forms of income splitting by creating attribution and gift rules.
Attribution rules heavily tax the income of any related family member who receives income from a business but hasn’t made a “sufficient” contribution.
The CRA attributes income claimed by one family member – usually the lower earner – back to the spouse who actually earned it.
These attribution rules only apply to dividends and capital gains, not wages or salaries. Wages and salaries are subject to CRA’s Reasonableness test, which examines if the money the family receives is commensurate to what a hypothetical third party in a similar situation would earn.
Family-run businesses should understand which TOSI and salary rules apply to them and how they can affect their business’s bottom line during tax season.
The Gift Rules
Are you thinking about gifting your family vacation property or part of your inheritance to your children? While you ponder how you can help your loved ones, you should also start thinking about the potential tax consequences of your kind-hearted gesture.
For instance, what happens if you sell your company to your spouse? The CRA might see this as a gift, even if you don’t think of it that way.
The Income Tax Act has specific rules about gifts that have two primary goals:
- to ensure CRA gets their fair share of taxes on any accrued gain
- to prevent “abusive” income splitting transactions among related persons
Fair Market Value
When you gift property to someone who is not at “arm’s-length,” like a family member or spouse, and the consideration, or payment, is less than fair market value, then CRA deems that the non-arm’s-length relative received the fair market value of the property.
Note that your family member is only liable for accruals in value above the property’s fair market value at the time of transfer.
Automatic Roll Provisions
On the other hand, if you transfer or sell property to your spouse, the Income Tax Act automatically rolls over the transfer on a tax-deferred basis. This means that if you sell the shares of your jointly held company to your spouse, you won’t realize a taxable gain.
The only exception is if you opt out of the Income Tax Act and agree to be taxed at the time you transfer the assets.
While Canadian taxpayers usually aim to reduce their taxes payable, automatic roll provisions can prevent you from certain tax strategies like using your Lifetime Capital Gains Exemption (LCGE).
These are just two of the many rules you should be aware of if you’re gifting assets or exchanging property between family members.
When it comes to tax planning, it is always wise to understand the rules that apply to you before you get your tax return.
Contact Du Plooy Law to learn how to prepare yourself for tax season.
As of the date of publication, the contents of this article are believed to be accurate and reliable; however, tax laws are complex and subject to change on an annual basis. Before implementing any tax or succession plan, you should always consult professional legal and accounting advice.
This article is purely educational in nature and is not to be construed as legal advice. Du Plooy Law does not accept any liability for the tax consequences that may result from actions made based on this article.