Morneau’s newest income ‘sprinkling’ rules reach new heights of silliness. They’re also unfair
Source: Financial Post
Author: Allan Lanthier
Last week, the Department of Finance released revised proposals to address “income sprinkling” — proposals scheduled to take effect January 1st. While the rules are not the most complex in the history of Canadian tax, they are among the most absurd.
The tax policy concern is legitimate. An individual who owns a private corporation can arrange the corporation’s share structure so that other family members — such as a spouse and children — own shares as well. Income, including dividends and capital gains, can then be realized by family members who are at lower rates, or who may not be taxable at all. Existing law — the “split income” rules — addresses income sprinkling for children under age 18, by taxing dividends at the highest marginal tax rate (unless the income is from certain inherited property). However, the rules do not apply to adult family members. So how best to address this? Here’s one idea.
If an individual has a significant interest in a private corporation’s business, extend the split-income rules to other family members age 18 to 24, and apply the rules to both dividends and capital gains, with no reasonability exceptions. One or two lines of legislation would capture most of the tax at issue, while avoiding the uncertainties, compliance costs and endless disputes with the tax authorities that otherwise lie ahead.
But that would have been too easy. Here is a flavour of the new rules from Finance: If a spouse, child or sibling is over 17 years of age, dividends received from private corporations may be split income and be taxed at the highest marginal rate, unless the individual is actively involved in the corporation’s business on a “regular, continuous and substantial basis,” either in the year or in any five prior taxation years (including years before 2018). An individual is considered to have met this test if he or she worked an average of 20 hours a week in those years.
And how does someone demonstrate compliance with the 20-hour requirement? The Canada Revenue Agency says that taxpayers should keep timesheets, schedules or logbooks. But that is not how family businesses operate. And there will generally be no records whatever for years prior to 2018, before Finance dreamt up this test.