Tax on split income – Excluded shares 

Tax on split income (TOSI) relates to the rules for determining whether an individual will be taxed at the highest marginal tax rate on income derived from a business. Starting with the 2018 tax year, these updated rules apply for adults aged 18 or older.

Individuals may be excluded from TOSI if the income they receive in the year comes from excluded shares, provided they reached the age of 25 before the end of the year in which the income was received. This page provides a series of examples which can help these individuals determine whether their income is derived from excluded shares.

For more information about the new rules and the related exclusions, see Guidance on the application of the split income rules for adults.

Excluded shares—Definition

Excluded shares are defined in subsection 120.4(1) of the Income Tax Act as shares of a corporation that are owned directly by an individual and that meet all of the following conditions when the income is received by the individual:

  1. The gross business income test reveals that less than 90% of the business income of the corporation was from providing services (based on the corporation’s previous tax year or, for new corporations, its current tax year).
    Applying the gross business income test

    In determining if a corporation derives less than 90% of its business income from the provision of services, business income means gross business income (the gross business income test). 

    In general, gross business income means revenue or sales before any expenses. Gross business income does not include capital gains.

    If a corporation carries on more than one business, the test will apply to the gross business income of all of the businesses added together.

    In circumstances where the corporation distributing income to the individual has an off-calendar year-end, eligibility for the exclusion is based on the corporation’s last tax year-end.

    For example, if a corporation has a June 30 year-end, eligibility for the exclusion for dividends declared and paid on June 29, 2018, will be based on the corporation’s June 30, 2017, tax year-end. Eligibility for dividends declared and paid on September 30, 2018, will be based on the corporation’s June 30, 2018, tax year-end.

  2. The corporation is not a professional corporation (one that, as defined in subsection 248(1) of the Act, carries on the professional practice of an accountant, dentist, lawyer, medical doctor, veterinarian, or chiropractor).
  3. The individual directly owns shares amounting to at least 10% of the fair market value of the issued and outstanding capital stock of the corporation and giving the individual 10% or more of the votes that could be cast at an annual meeting of the shareholders of the corporation.
  4. All or substantially all (generally this means 90% or more) of the income of the corporation for its previous tax year is not derived directly or indirectly from one or more related businesses, as defined in subsection 120.4(1) of the Act in respect of the individual, other than a business of the corporation.

Examples of scenarios where the gross business income test is applied

The Canada Revenue Agency (CRA) collaborated with external stakeholders to develop the following examples. Consultations are ongoing and may highlight the need for more examples to be added.

The following examples show how to apply the gross business income test to determine if less than 90% of the business income of a corporation is from providing services.

In each example, the corporation has a December 31 year-end and a dividend has been paid by the corporation to the individual in 2018. It is assumed that the following conditions are also met:

If the gross business income test is met in the examples, the individual’s shares would qualify as excluded shares.

Example 1: General calculation 

Facts

  • A corporation carries on a management consulting business that provides services to other businesses and sells computer hardware to its clients
  • Gross business income of the corporation for the previous tax year (2017): $2,000,000 made up as follows:
    • sales of management consulting services (2017): $1,900,000
    • sales of computer hardware (2017): $100,000
  • Gross business income test: $1,900,000 ∕ $2,000,000 = 95%

Conclusion

Since more than 90% of the gross business income of the corporation in the previous tax year was for services, the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares is not met. So the shares of the corporation would not qualify as excluded shares for 2018.

Example 2: New business

Facts

  • A corporation incorporated and began operating a business in 2018
  • There is no previous tax year
  • The corporation carries on a management consulting business that provides consulting services to other businesses and sells computer hardware to its clients
  • Gross business income of the corporation (2018): $1,000,000 made up as follows:
    • sales of management consulting services (2018): $990,000
    • sales of computer hardware (2018): $10,000
  • Gross business income test: $990,000 ∕ $1,000,000 = 99%

Conclusion

Since more than 90% of the business income of the corporation in the current tax year was for providing services, the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares is not met. So the shares of the corporation would not qualify as excluded shares for 2018.

Note

The shares of the corporation would also not qualify as excluded shares for 2019. Since the 90% test is applied to the previous tax year of the corporation when such a year exists, the 2018 tax year would be used again when determining if the shares qualify as excluded shares for 2019.

Example 3: Result of 90% test varies from one year to another

Facts

  • A corporation operates a plumbing business
  • The main business activity is providing repairs and maintenance services
  • The corporation also operates a retail store to sell parts and plumbing fixtures. The retail products are not used in providing the services, but are sold separately to customers
  • Gross business income of the corporation (2017): $1,000,000 made up as follows:
    • sales of repairs and maintenance services (2017): $950,000
    • sales of parts and fixtures (2017): $50,000
  • Gross business income test applied to income from 2017: $950,000 ∕ $1,000,000 = 95%
  • Gross business income of the corporation (2018): $1,200,000 made up as follows:
    • sales of repairs and maintenance services (2018): $900,000
    • sales of parts and fixtures (2018): $300,000
  • Gross business income test applied to income from 2018: $900,000 ∕ $1,200,000 = 75%

Conclusion

Since more than 90% of the gross business income of the corporation in the previous tax year (2017) was for services, the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares is not met. So the shares of the corporation would not qualify as excluded shares for 2018.

However, in applying the test in 2019 using the 2018 amounts, less than 90% of the business income of the corporation was for services, so the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares would be met. The shares of the corporation would qualify as excluded shares for 2019.

Example 4: Incidental goods used or consumed in providing services 

Facts

  • A corporation operates a cleaning business that provides cleaning services
  • The corporation does not sell cleaning products, but uses them in providing services to its customers
  • Gross business income of the corporation (2017): $1,000,000
  • Sales of services (2017): $1,000,000
  • The cost of cleaning products used for the services was $150,000
  • Gross business income test: $1,000,000 ∕ $1,000,000 = 100%

Conclusion

Since more than 90% of the business income of the corporation in the previous tax year was for services, the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares was not met. So the shares of the corporation would not qualify as excluded shares for 2018.

In this example, the cleaning products are incidental to the services, since they were used in providing the services. So the incidental goods amount ($150,000 cost of the cleaning products) would not be subtracted from the service part of the gross business income.

This would still be the case if an amount for the goods was listed separately on the invoice for services or on a separate invoice.

Example 5: Income from both services and non-services – Cleaning business

Facts

  • Assume the same facts as in Example 4, except that the business also sells various cleaning supplies and equipment separately
  • The cleaning supplies and equipment may be sold to retail customers who are not customers of the service business, or they may be sold to customers when they are buying cleaning services
  • Gross business income of the corporation (2017): $1,000,000 made up as follows:
    • Sales for cleaning services (2017): $800,000
  • Sales of cleaning supplies and equipment (2017): $200,000
  • Gross business income test: $800,000 ∕ $1,000,000 = 80%

Conclusion

Since less than 90% of the business income of the corporation is for services, the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares is met. So the shares of the corporation would qualify as excluded shares in 2018.

If goods are provided with a service and the goods are not incidental to the service, because they are provided separately for use by the customer, the sale price allocated to the goods is not included as service income in applying the gross business income test.

In this example, the business had sales of cleaning supplies and equipment that were not incidental to the services, since they were either sold separately or, if sold with a cleaning service, were distinct and separate from the cleaning service. So the $200,000 in sales of the cleaning supplies and equipment would not be included in the service part of the gross business income.

Any incidental goods used or consumed in performing the cleaning services would not be subtracted from the service part of the gross business income.

Example 6: Income from both services and non-services – Construction business

Facts

  • A corporation operates a business that includes the design, construction and repair of decks
  • When constructing and repairing decks, the corporation supplies all materials and labour
  • For a fee, the corporation also designs decks and provides plans to customers who want to build the deck on their own
  • Gross business income of the corporation (2017): $200,000 made up as follows:
    • Deck construction: $175,000:
      • Materials $90,000
      • Labour $85,000
    • Deck repairs: $20,000:
      • Materials $10,000
      • Labour $10,000
    • Deck design: $5,000
  • Gross business income for services: $100,000 ($200,000 − $90,000 − $10,000)
  • Gross business income test: $100,000 ∕ $200,000 = 50%

Conclusion

Since less than 90% of the business income from all activities of the corporation is for services, the condition in subparagraph 120.4(1)(a)(i) of the definition of excluded shares is met. So the shares of the corporation would qualify as excluded shares in 2018.

In this example, the income from deck construction and deck repair involve both a service and non-service component. The non-service component (i.e. sale of materials) must be removed from the gross business income in order to identify the income derived from services when applying the gross business income test.

The deck design is considered to be a service.

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