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taxcoalition 18 | winter 2018 cmba-achc.ca CMB MAGAZINE SPOUSE A 75% SPOUSE B 25% SPOUSE A 75% SPOUSE B 25% SPOUSE A 50% SPOUSE B 50% SPOUSE A 50% SPOUSE B 50% SPOUSE A 75% SPOUSE B 25% SPOUSE A SPOUSE B Income SplIttIng EXAMPLE "Excluded Share" exclusion not available to common structures FACTS • Business is a start-up manufacturing company • Spouse A is the primary business operator Spouse B has many informal roles in the business, however, does not meet 20 hours per week bright line test for "excluded business" carve out. EXAMPLE Excluded Business - Application to Multiple Businesses FACTS • Spouse A founded and operates a construction business and a property management business. • Both businesses are operated through a single corporate entity (Opco) • Spouse B works 25 hours per week as a property manager EXAMPLE Excluded Business - Application to Multiple Businesses FACTS • Spouse A founded and operates a construction business and a property management business. • Both businesses are operated through a single corporate entity (Opco) • Spouse B works 25 hours per week as a property manager ScenarIo 1 – DIrect ownerShIp ScenarIo BuSIneSS 1 – haIr Salon BuSIneSS 2 – pIzzerIa ScenarIo 2 – ownerShIp through a holDIng company ScenarIo – ownerShIp through a truSt The shares owned by spouse B meet the definition of "Excluded Shares." The company does not derive more than 90% of its business income from the provision of services, and the shares owned by Spouse B give him more than 10% of the votes that can be cast, and represent greater than 10% of the fair market value of the company. All or substantially all of the income of the corporation is not from a related business. CONCLUSION: New income sprinkling rules do not apply. Dividends can be paid to Spouse B. The "Excluded Business" definition states that where Spouse B works at least 20 hours per week in the business. In this case, Spouse B works 2 5 hours in the property management business, but not the construction business. Do we now have to trace the flow of funds from the property management business to Spouse B to ensure they are "excluded amounts"? Conclusion: New income sprinkling introduce significant administrative complexity that may not be possible to manage in ordinary business settings. It may be impossible to trace source of funds that Spouse B receives as dividends. If this isn't possible, dividends to Spouse B will be subject to the Tax on Split Income . The company derives more than 90% of its business income from the provision of services. Therefore, the shares do not meet the definition of "Excluded Shares" CONCLUSION: New income sprinkling rules apply. Dividends paid to Spouse B are subject to Tax on Split Income. The company does not derive more than 90% of its business income from the provision of services. Therefore, the shares do meet the definition of "Excluded Shares" CONCLUSION: New income sprinkling rules do not apply. Dividends can be paid to Spouse B. The economic interests are exactly the same as in Scenario 1. However all or substantially all of the income of Holdco is income derived from a related business, Opco. Therefore the shares owned by Spouse B are not excluded shares. CONCLUSION: New income sprinkling rules apply. Dividends paid to Spouse B are subject to Tax on Split Income at the highest marginal tax rate. The economic interests are exactly the same as in Scenario 1. However, the shares are owned by a trust, not by the specified individual (Spouse B). Therefore, the shares of Opco are not excluded shares CONCLUSION: New income sprinkling rules apply. Dividends paid to Spouse B through the trust are subject to Tax on Split Income at the highest marginal tax rate. OPCO OPCO CONSTRUCTION BUSINESS PIZZERIA (SALE OF GOODS) HOLDCO FAMILY TRUST OPCO OPCO 100% CONCLUSION: Three common structures that exist for both tax and non-tax reasons (i.e. creditor protection, estate planning, etc.) have vastly different results. Any level of complexity introduced to the structure will result in the Exclusions provided for in the legislation not being available to specified individuals. CONCLUSION: Significantly different results are applicable to two similar small businesses. Given that 78% of Canadian small businesses are in the service sector, it is unclear why this exclusion should not be available to services businesses. Examples provided by: MNP LLP CONSTRUCTION BUSINESS PROPERTY MANAGEMENT BUSINESS

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