This article is taken from our quarterly overview of Canadian news, a newsletter published by the Canadian member firms of
Moore Stephens North America
. It is part of our mission to be the partner of choice for your success, by keeping you informed of the latest news and developments..
The effect of holding companies on income splitting
In 2017, new rules came into effect to limit the use of income splitting, which allowed Canadian residents to split income with family members. These new rules are known as impôt sur le revenu fractionné (“IRF”). The IRF applies when a family member has not contributed to or worked in a family business; it may vary according to age. For family members under 18, income splitting is limited. The rules are less restrictive for family members aged 18 to 24, and even less so for family members over 24. A special exemption applies to people whose spouses aged 65 or over were active in the company.
Details of the rules are beyond the scope of this article. However, we’d like to introduce you to a business structure that against all odds is subject to these rules: a structure where an operating company is owned by a holding company, where the holding company is owned by an owner/operator, and where the owner’s spouse, adult children (over the age of 25) and family members are not actively involved in the business.
One exclusion from IRF, known as “excluded shares”, applies to dividends. For a company owned by a taxpayer to consist of excluded shares, it must meet the following conditions:
a. This is NOT a professional company.
b. Less than 90% of last year’s business income came from the provision of services.
c. The taxpayer holds at least 10% of the voting rights AND at least 10% of the value of the company.
d. 90% (i.e. all or almost all) of corporate income is NOT derived from other affiliated companies.
The rules stipulate that even if the 10% shareholding criterion is met, holding companies do not meet the criteria for excluded shares, for a number of reasons.
First of all, they don’t generate any business income. As mentioned in point “b” above, the rule is that less than 90% of business income comes from the provision of services. CRA believes this means that the company must first generate business income, and that 90% of this business income must not come from the provision of services. If a holding company only derives dividends from its subsidiaries or investment income from its assets, it does not generate any business income and therefore does not meet the criteria for excluded shares.
If the holding company receives fees from the operating company to generate business income, the criterion set out in point “d” could be problematic. Business income must come from an unrelated business.
In fact, owning a holding company can be a problem if you want to avoid IRF. Talk to your advisor to see if you are subject to IRF and to assess your tax planning options.
With contributions fromHoward Wasserman, CPA, CA, CFP, TEP of Segal LLP, Toronto. This article was written as part of the Quarterly Canadian Snapshot, a newsletter published by the Canadian member firms of Moore Stephens North America.
