Navigating the TOSI Rules: Income Splitting & How to Legally Split Corporate Income with Family

Overview– Why the TOSI Rules Remain a Risk for Family Business Tax Planning

The Tax on Split Income (TOSI) rules remain among the most complex and misunderstood areas of Canadian private corporation tax planning. Found in section 120.4 of the Income Tax Act, these rules were significantly expanded effective January 1, 2018, to restrict income-splitting arrangements involving private corporations, family trusts, partnerships, and related family members.

The 2018 expansion responded to this earlier legal landscape. Before the expanded TOSI regime, certain income-splitting structures involving private corporations were difficult for the CRA to challenge under the existing attribution rules. 

In Neuman v. The Queen, [1998] 3 C.T.C. 177 (SCC), the Supreme Court of Canada declined to use subsection 56(2) of the Income Tax Act to reallocate dividends paid under a dividend-sprinkling structure. Similarly, in Ferrel v. The Queen, [1998] 1 C.T.C. 2269 (TCC), aff’d [1999] 2 C.T.C. 101 (FCA), the courts did not apply subsection 56(2) to a management-services arrangement involving a trust. 

These decisions helped illustrate that traditional attribution and indirect-payment rules were not always sufficient to address income splitting through private corporations, particularly where the planning did not involve a below-market transfer of property or a below-market loan.  However, under the current TOSI regime, income earned through private corporations connected to these types of structures may now be caught by the split-income rules.

Parliament responded by expanding the TOSI rules into a broader and more mechanical regime. Rather than relying only on traditional attribution rules, the expanded rules directly target certain forms of income splitting involving private corporations, partnerships, trusts, and related family members. Where the rules apply, dividends, shareholder benefits, trust or partnership allocations, and certain capital gains connected to a related private business may be taxed at the highest personal marginal tax rate.

This change significantly altered the tax-planning landscape for family-owned businesses. Before the expanded TOSI regime, many private corporations could, in appropriate circumstances, pay dividends to spouses, adult children, or other family members who held shares of the corporation. Those corporate dividends could generally be taxed in the hands of the recipient family member, often at a lower marginal tax rate. This planning was especially common in owner-managed businesses, professional corporations, and family business structures where different classes of shares were used to distribute corporate income among family members.

The difficulty is that TOSI does not operate like a simple anti-avoidance rule. It does not necessarily require a tax-avoidance purpose or abusive planning. Instead, it applies through a highly technical framework that asks whether the recipient is a specified individual, whether the income is split income, whether there is a source individual or related business, and whether an exclusion applies. For many taxpayers, the most important question is not simply whether a family member received income from a private corporation, but whether that income qualifies as an excluded amount.

This makes TOSI planning especially challenging for family-owned businesses. A dividend paid to an adult child, a spouse, or a family trust beneficiary may be fully taxable at the highest marginal rate unless the recipient can rely on an exclusion such as excluded business, excluded shares, reasonable return or safe harbour capital return. Each exclusion has its own technical requirements, and the practical outcome often depends on evidence of labour contribution, capital contribution, risk assumed, ownership structure, age, and the nature of the corporation’s business.

For accountants and business owners, the key lesson is that TOSI must be reviewed before dividends or other distributions are paid, not after a Canada Revenue Agency tax audit or tax reassessment begins. Proper planning requires a careful review of the corporation’s share structure, family member involvement, prior-year work history, capital contributions, trust allocations, and available documentation. For taxpayers using private corporations for estate planning, succession planning, or income splitting, guidance from an experienced tax lawyer in Toronto can be critical in determining whether the structure remains defensible under the TOSI rules.

Common Family Business Structures Caught by TOSI

A simple example helps explain how the TOSI rules operate in practice when a family-owned private corporation pays dividends or allocates income to related family members.

Assume that a dentist carries on her practice through a professional corporation. The corporation has several classes of non-voting shares. The dentist owns the voting shares, while her spouse and two adult children each own a separate class of non-voting shares. The share structure gives the corporation flexibility to declare dividends on one class of shares without declaring the same dividends on the other classes.

Before the expanded TOSI rules, this type of structure could sometimes be used to distribute after-tax corporate earnings to family members in lower tax brackets. For example, the corporation might pay dividends to the spouse or adult children even though they did not work full-time in the practice or contribute significant capital to the business. If the traditional attribution rules did not apply, the dividends could be taxed in the hands of the family member who received them.

A similar planning result could sometimes be pursued through a family trust. For example, a family trust might hold shares of an operating corporation, receive dividends from that corporation, and then allocate income to beneficiaries who were family members of the business owner. In other structures, management or service arrangements could be used to move business income through a related entity or trust before amounts were distributed to family members.

The expanded TOSI rules changed the analysis. The question is no longer simply whether a dividend was legally paid to a family shareholder or allocated through a trust. The more important question is whether the amount is split income under section 120.4 of the Income Tax Act and, if so, whether the recipient qualifies for an excluded amount.

Returning to the dentist example, a dividend paid to the spouse or adult children may now be taxed at the highest marginal tax rate if the recipient does not meet a TOSI exclusion. A family member who works regularly and substantially in the business may be able to rely on the excluded business exception. An adult family member aged 24 or older may need to consider the excluded shares or reasonable return exceptions. But where the family member merely holds shares and receives dividends without meaningful labour, capital, or risk contribution, the income-splitting benefit may be eliminated.

This is why TOSI planning is highly fact-specific. The same corporate structure may produce different tax results depending on the recipient’s age, role in the business, ownership percentage, capital contribution, risk assumed, and the nature of the corporation’s activities. For family-owned businesses, the practical issue is not whether income sprinkling is theoretically possible, but whether the specific recipient can support a statutory exclusion if the CRA reviews the dividends during a tax audit.

Core TOSI Concepts – Specified Individuals, Source Individuals, Related Businesses, and Excluded Amounts

The basic operation of the TOSI rules can be stated simply, even though the statutory framework is highly complex. If an individual receives certain income from a private corporation, partnership, or trust connected to a related business, that income may be treated as split income unless the individual qualifies for a specific exclusion. When TOSI applies, the income is taxed at the highest marginal tax rate rather than at the recipient’s ordinary marginal rate.

This is what makes TOSI so significant for family-owned businesses. The rules do not merely deny a particular deduction or adjust a specific transaction. Instead, they can eliminate the tax benefit of income splitting by taxing the recipient as though they were already in the highest tax bracket. In practical terms, a dividend paid to a lower-income family member may produce little or no tax savings if the amount is caught by TOSI.

TOSI is also different from many traditional anti-avoidance rules because it does not require the CRA to prove that the taxpayer had an abusive tax avoidance purpose. The rules operate mechanically. If the statutory conditions are met, the tax may apply even if the family corporation was created for legitimate business, estate-planning, or succession-planning purposes. The taxpayer’s motive may explain why the structure was created, but it does not, by itself, determine whether the income is split income.

For adult recipients, the analysis generally starts with three core concepts: the specified individual, the source individual, and the related business. The source individual is generally the related person whose business, involvement, or ownership connection gives rise to the income-splitting concern. The specified individual is the person who receives the income and may be subject to TOSI. The related business is the business carried on directly or indirectly by, or sufficiently connected to, that related person.

This framework matters because TOSI is aimed at income that is connected to a related private business. For example, dividends from a private corporation, shareholder benefits, trust or partnership allocations, interest from certain private business structures, and some capital gains connected to private corporation shares or debt may all raise TOSI issues. By contrast, salary and ordinary employment remuneration are not subject to TOSI, although they remain subject to the ordinary rule that deductible amounts must be reasonable. An unreasonable salary may create other tax problems, including deductibility issues or shareholder-benefit concerns, but it is not analyzed in the same way as a dividend under TOSI.

Once an amount is potentially split income, the real question becomes whether it is an excluded amount. This is where most practical TOSI planning occurs. Depending on the recipient’s age and circumstances, an amount may be excluded because it comes from an excluded business, because the recipient holds excluded shares, because the payment represents a reasonable return, because the recipient contributed arm’s-length capital, or because another specific statutory exception applies.

The recipient’s age is especially important. The rules are generally more restrictive for minors and for individuals between 18 and 24. Adults who are 24 or older may have broader access to exclusions, such as excluded shares and reasonable return, but those exclusions are not automatic. They require a careful review of the corporation’s business, the recipient’s share ownership, the recipient’s work or capital contribution, the risks assumed, and the amounts previously paid to that recipient.

The limited availability of tax credits also increases the cost of being caught by TOSI. When income is subject to TOSI, the recipient cannot simply rely on the usual personal credits to reduce the tax in the ordinary way. This reinforces the punitive effect of the rules and explains why the income-splitting benefit is often eliminated when TOSI applies.

For family-owned private corporations, the practical takeaway is that TOSI is not a last-minute reporting issue. It is a planning and evidence issue. A dividend that looks efficient on paper may become expensive if the corporation cannot show why the recipient was entitled to receive it outside the TOSI regime. Before dividends, trust allocations, shareholder benefits, or related-party payments are made, taxpayers should determine whether the recipient is exposed to TOSI and whether the file contains enough evidence to support an excluded amount. That evidence may include work records, capital contribution records, shareholder registers, loan documents, guarantees, compensation comparisons, corporate resolutions, and trust allocation records. 

Where a TOSI issue arises during a CRA audit or tax reassessment, guidance from an experienced Toronto tax lawyer can be critical in responding to CRA disputes and defending the taxpayer’s filing position.

What Counts as Split Income Under Section 120.4?

After identifying the relevant family relationship and related business, the next step is to determine whether the particular amount received falls within the statutory concept of “split income” under section 120.4 of the Income Tax Act. This step is important because the TOSI rules do not apply to every amount received by a family member connected to a private business structure. They apply only to specific categories of income, gains, or benefits that Parliament has chosen to bring within the split-income regime.

The expanded TOSI rules are especially important for family-owned private corporations because income may be moved directly through share ownership or indirectly through trusts, partnerships, debt arrangements, shareholder benefits, or capital transactions. In practical terms, the rules are not limited to ordinary dividends paid directly from an operating corporation to a family shareholder.

The main categories of amounts that may be treated as split income include: (i) taxable dividends and shareholder benefits received directly or indirectly from a private corporation, including amounts received through a trust or partnership; (ii) income derived from a related business, including income connected to a business carried on by a related person or by a corporation, partnership, or trust in which a related person is sufficiently involved; (iii) income from certain debt obligations of private corporations, partnerships, or trusts; and (iv) taxable capital gains or other income from the disposition of shares or debt of a private corporation.

The capital-gains component is particularly important because TOSI is not confined to annual dividend distributions. In some circumstances, the rules may apply when a family member disposes of shares or debt connected to a private corporation. The rules can also apply to certain capital gains realized by minors on dispositions of shares to non-arm’s-length persons where dividends on those shares would have been subject to TOSI. This prevents taxpayers from avoiding the split-income regime by converting what would otherwise be dividend income into a capital gain.

The practical result is that TOSI can reach several common private-corporation planning arrangements. Dividend sprinkling remains the most obvious example, but the analysis may also extend to shareholder benefits, family trust distributions, partnership allocations, interest on private-corporation debt, and certain capital transactions involving private corporation shares or debt. In some cases, the same issues may arise in broader planning structures, including holding-company arrangements or estate-freeze structures, depending on how income, dividends, or redemption proceeds are paid or allocated to family members.

This broader scope is why owner-managers and accountants should avoid treating TOSI as only a “dividend rule.” The better question is whether the amount received by the family member is connected to a private corporation, related business, trust, partnership, or private-corporation property in a way that brings it within the statutory definition of split income. If it does, the analysis then turns to whether an excluded amount is available.

How TOSI Applies Based on the Recipient’s Age

The scope and severity of the TOSI rules depend heavily on the age of the family member receiving the income. This is one of the most important features of section 120.4 of the Income Tax Act. The same dividend, trust allocation, or shareholder benefit may produce different tax results depending on whether the recipient is a minor, a young adult, or an adult aged 24 or older.

For family-owned private corporations, this means that TOSI planning must be done recipient by recipient. It is not enough to ask whether the corporation can pay dividends to “the family.” The correct question is whether each particular recipient can rely on an exclusion based on age, work performed, capital contributed, risk assumed, share ownership, or another statutory rule.

Children Under 17

The TOSI rules are most restrictive for minors. In general terms, a child under 17 may be subject to TOSI on split income connected to a private corporation, trust, partnership, or related business. This includes common income-splitting amounts such as dividends from private corporation shares, shareholder benefits, and trust or partnership income connected to a related person’s business.

Where TOSI applies to a minor, the income is taxed at the highest marginal rate rather than at the child’s ordinary marginal rate. This is why the former “kiddie tax” was so effective in eliminating many traditional income-splitting benefits involving children. The rule prevents a family-owned private corporation from simply shifting business income to a minor child in a lower tax bracket.

The rules can also affect capital gains planning involving minors. Where a minor realizes a taxable capital gain on certain non-arm’s-length dispositions of private corporation shares, section 120.4 can deem the amount not to be a taxable capital gain and instead treat twice the amount as a taxable dividend that is not an eligible dividend. This can eliminate access to the ordinary capital-gains treatment in that context and may produce a much harsher tax result.

For owner-managers, the practical point is that paying dividends or allocating trust income to minor children is generally high risk unless a specific exclusion clearly applies. Family trusts with minor beneficiaries should be reviewed carefully before dividends are allocated, especially where the trust holds shares of a private corporation connected to a parent’s business.

Individuals Aged 18 to 24

The rules remain restrictive for individuals aged 18 to 24, but the analysis becomes more fact-specific. For this age group, TOSI generally focuses on whether the amount is connected, directly or indirectly, to a related business. If the amount does not derive from a related business, it may fall outside the TOSI regime. If it does derive from a related business, the recipient must look for an available exclusion.

The most important exclusion for this age group is often the excluded business exception. An amount may be excluded if the individual is actively engaged on a regular, continuous, and substantial basis in the business in the year or in any five prior taxation years. Those five prior years do not need to be consecutive.

Paragraph 120.4(1.1)(a) provides an important bright-line rule. An individual is deemed to be actively engaged on a regular, continuous, and substantial basis if the individual works in the business at least an average of 20 hours per week during the portion of the year in which the business operates. For seasonal businesses, the test is applied during the period when the business is actually operating.

Where the individual does not meet the 20-hour threshold, the analysis becomes more uncertain. The taxpayer may still argue that the individual was actively engaged based on the facts, but there is no automatic safe harbour. The nature of the tasks, the regularity of the work, the time spent, and the individual’s role in the business will all matter.

For this reason, documentation is critical. A young adult who works in a family business should keep records showing the hours worked, tasks performed, responsibilities assumed, and continuity of the work. Without that evidence, the CRA may challenge whether the individual was truly actively engaged in the business.

Adults Aged 24 or Older

Adults aged 24+ and older may have broader access to TOSI exclusions. In addition to the excluded business exception, they may be able to rely on the excluded shares exception or the reasonable return exception. This makes the analysis more flexible, but it does not make TOSI irrelevant.

The excluded shares exception may apply where the adult family member owns a sufficient interest in the corporation and the corporation satisfies the statutory conditions. In general terms, the individual must hold shares representing at least 10% of the votes and value of the corporation. The corporation must also meet important business-activity requirements, including restrictions where the corporation earns most of its income from services or where its income is derived from another related business. Professional corporations do not qualify for the excluded shares exception.

The reasonable return exception may also be important for adults aged 24 or older. This exception looks at whether the amount received reasonably reflects the individual’s contribution to the related business. Relevant factors may include the work performed, property contributed, risks assumed, prior amounts paid or payable, and other relevant circumstances. This can be important where a spouse or adult child does not work full-time in the business but has provided services, capital, guarantees, or other meaningful support.

The practical result is that adults aged 24 or older may have more planning options, but the payment still needs to be defensible. A dividend paid simply because the person is a family member or shareholder may not be enough. The corporation should be able to identify the exclusion being relied on and maintain evidence supporting that position.

For accountants and owner-managers, the age-based structure of TOSI is central to planning. Minors are subject to the most restrictive rules. Individuals aged 18 to 24 require careful review of active engagement, related-business status, and capital-based exclusions. Adults aged 24 or older may have broader access to excluded shares and reasonable return, but those exceptions must be supported by the facts. Where a CRA audit or tax reassessment challenges dividends or trust allocations to family members, guidance from an experienced Canadian tax lawyer can be critical in determining which age-based exclusion, if any, applies.

Key TOSI Exclusions – When Split Income Becomes an Excluded Amount

Subsection 120.4(1) of the Income Tax Act defines several categories of “excluded amounts.” These exclusions are important because an amount that would otherwise be split income may be removed from the TOSI regime if it falls within one of those categories. 

The exclusions cover, among other things, certain inherited property, property received on a marriage or common-law relationship breakdown, capital gains arising on death, gains eligible for the lifetime capital gains exemption on qualified small business corporation shares or qualified farm or fishing property, income from an excluded business, safe harbour capital returns, excluded shares, and reasonable returns.

The availability of an excluded amount depends heavily on the recipient’s age, relationship to the business, contribution to the business, share ownership, capital contribution, and commercial risk. In general, the rules are more restrictive for minors and for individuals between 18 and 24. Once an individual is aged 24 or older, additional exclusions may become available, including the excluded shares and reasonable return exceptions. However, these exclusions are not automatic and must be supported by the facts.

The Excluded Business Exception

The excluded business exception is based mainly on meaningful labour contribution. An amount may be excluded from TOSI if the recipient was actively engaged on a regular, continuous, and substantial basis in the business, either in the year in which the income is received or in any five prior taxation years. Those five prior years do not need to be consecutive.

In practical terms, this exception is important for family members who actually work in the business. A person who helps occasionally or performs minor tasks may not satisfy the test. By contrast, a family member who has a regular role, spends significant time in the business, and contributes real work may have a stronger basis for relying on this exclusion.

The Income Tax Act also provides a practical benchmark. If the individual works an average of at least 20 hours per week during the part of the year when the business operates, the individual is generally deemed to be actively engaged in the business. This is especially relevant for seasonal businesses, where the 20-hour test is measured over the period when the business actually operates.

For owner-managed businesses, the excluded business exception makes documentation critical. Work schedules, emails, job descriptions, payroll records, calendar entries, client communications, and evidence of decision-making can all help demonstrate that the family member’s involvement was regular, continuous, and substantial.

The Safe Harbour Capital Return Exception

The safe harbour capital return exception may apply where the recipient has contributed capital or property to the business and the amount received does not exceed the safe harbour rate of return.

The safe harbour return is calculated by applying the highest prescribed quarterly rate for the year to the fair market value of the property contributed, taking into account the period during which that property was used in the business. As a result, this exception is narrow. It does not exclude any amount simply because a family member contributed property; the amount must fit within the statutory safe-harbour calculation.

From a planning perspective, the taxpayer should be able to show what property was contributed, its fair market value, when it was contributed, how long it was used in the business, and how the safe harbour return was calculated. Without that evidence, it may be difficult to support the position that the amount is an excluded safe harbour capital return.

The Reasonable Return Exception

The reasonable return exception may apply where the amount received by a family member reasonably reflects that individual’s contribution to the related business. The determination is fact-specific and may take into account the work performed in support of the related business, the property contributed to the business, the risks assumed in respect of the business, the total amounts previously paid or payable to the individual in connection with the business, and any other relevant factors.

This exception is especially important for individuals aged 24 or older because the reasonable return analysis may consider a broader range of contributions. For example, a spouse who does not work 20 hours per week may still have provided valuable services, contributed capital, guaranteed corporate debt, pledged personal assets, or assumed meaningful risk in connection with the business. In those circumstances, a dividend or other amount may be defensible if it reasonably reflects that contribution.

A more specific version of this analysis applies where the taxpayer relies on a reasonable return on arm’s-length capital. In that context, if the split income represents a reasonable return having regard only to the recipient’s contribution of arm’s-length capital, the amount may qualify as an excluded amount. The focus is therefore on the capital contributed by the recipient and whether the return is reasonable in light of that contribution.

Capital may not qualify as arm’s-length capital if it was transferred or loaned by a related person, except in limited circumstances such as death, or if it was derived from income, gains, or profits connected to another related business. In practical terms, arm’s-length capital will often be limited to inheritances, after-tax employment savings, or funds from an unrelated business.

The key point is that “reasonable return” is not a label that can be applied after the fact. The taxpayer should be able to explain why the amount paid was reasonable based on the recipient’s labour, property contribution, capital at risk, guarantees, prior payments, or other relevant circumstances. Without that evidence, a dividend or trust distribution may be vulnerable if the CRA reviews the arrangement during a tax audit or tax reassessment.

The CRA’s administrative approach also reinforces the importance of a good-faith analysis. In its guidance, the CRA has indicated that it will generally not substitute its own judgment for the taxpayer’s determination of a reasonable amount where the taxpayer made a good-faith attempt to apply the reasonableness criteria. However, that comfort is limited. The taxpayer must still be able to show that the amount was reasonable, having regard to the relevant facts and circumstances. As a result, family-owned corporations should not treat the reasonable return exception as an informal estimate or after-the-fact justification. The safer approach is to document the analysis before the payment is made, including the recipient’s work, property contribution, capital at risk, guarantees, prior payments, and any other facts supporting the amount paid.

For accountants, owner-managers, and family shareholders, the practical lesson is to analyze the exclusion before the payment is made. A family member’s age, work history, share ownership, capital contribution, and risk exposure should be reviewed before dividends, trust distributions, partnership allocations, or related-party payments are implemented. Where the facts are unclear or the CRA has raised the issue during an audit or tax reassessment, advice from an experienced Canadian tax lawyer can be critical in determining whether an excluded amount is available and how the taxpayer’s position should be documented.

Specific TOSI Relief for Death, Relationship Breakdown, Reinvested Income, and Spouses Age 65+

The TOSI rules also contain specific exclusions that are important in estate planning, family law, and retirement planning for family-owned private corporations. 

These rules reflect the fact that certain amounts should not be treated as income sprinkling simply because they are connected to a related individual, a private corporation, or family-owned property.

• First, TOSI does not apply to certain taxable capital gains arising because of the deemed disposition of property at death. This is important because death can trigger a deemed disposition for income-tax purposes, but that result is different from an income-splitting arrangement designed to shift private corporation income to a lower-rate family member.
• Second, TOSI may not apply where property is acquired because of a settlement arising from the breakdown of a marriage or common-law partnership, provided the statutory conditions are satisfied. This exclusion recognizes that transfers made in the context of a relationship breakdown are generally connected to the division of property rights rather than ordinary private corporation income sprinkling.
• Third, the TOSI rules were narrowed so that they generally do not apply indefinitely to income earned from reinvested split income, sometimes described as second-generation income. This is an important limitation because, without it, income once caught by TOSI could potentially taint future returns forever.

A separate relieving rule applies in the retirement-planning context for spouses and common-law partners of business owners who are age 65 or older. In broad terms, TOSI may not apply to dividends paid to a business owner’s spouse or common-law partner where the contributing business owner has reached the relevant age threshold and the amount would have been an excluded amount if received by that business owner. 

This approach is similar in policy to pension income splitting, because it may permit some income splitting with a spouse or common-law partner once the contributing business owner has reached retirement age.

This rule can be particularly relevant for professional corporations and other family-owned private corporations where one spouse built, operated, or contributed meaningfully to the business, while the other spouse holds shares or receives dividends. Relieving rules may also apply where the contributing business owner dies before reaching the relevant age threshold, but the specific statutory conditions should be reviewed carefully.

For owner-managers, the practical point is that these exclusions can be valuable, but they are not a substitute for careful planning. Death, marriage breakdown, reinvested split income, and retirement-age spousal dividends may change the TOSI analysis, but each situation depends on the statutory conditions and the supporting facts. 

Where a CRA audit or tax reassessment raises TOSI issues in an estate, separation, retirement, or professional-corporation context, guidance from an experienced Canadian tax lawyer can be critical in determining whether one of these specific exclusions applies.

Restructuring Options for Family-Owned Businesses Under the TOSI Rules

For family-owned private corporations, TOSI planning is not simply about avoiding dividends to family members. The better approach is to review the existing structure and determine whether income can be paid, allocated, or reorganized in a manner consistent with the Income Tax Act and supported by the underlying facts. 

Accountants advising owner-managed businesses should consider whether the corporation’s compensation policy, share structure, trust arrangements, capital contributions, and related-party financing remain appropriate under the expanded TOSI regime. 

There are various options to consider:

Replace unsupported dividends with reasonable salary or employment compensation where a family member actually works in the business. 

Salary is not subject to TOSI in the same way as dividends, but it must still be reasonable having regard to the work performed. This option may be useful where a spouse, adult child, or other family member provides bookkeeping, administrative, marketing, management, technical, or operational services to the business. 

Properly structured salary can also allow the recipient to build RRSP contribution room and Canada Pension Plan contributions, but the corporation should keep evidence of the services performed, hours worked, market compensation, and payment records. An unreasonable salary may create separate tax problems, including denial of deductibility or shareholder-benefit concerns. (section 67)

Review whether dividends can be supported by one of the excluded amount rules

This requires a recipient-by-recipient analysis. A family member who works regularly and substantially in the business may be able to rely on the excluded business exception. 

A family member who contributed capital, assumed risk, or provided services may be able to support a reasonable return. A shareholder who is aged 24 or older may also need to consider whether the excluded shares exception is available. 

The planning should not assume that all family shareholders are in the same position; the same dividend may produce different TOSI results for different recipients depending on age, work history, ownership, capital contribution, and risk exposure. (subsection 120.4(1))

Revisit the corporation’s share structure

Many family corporations historically used discretionary dividend shares, family trusts, or multiple classes of shares to distribute income among family members. Those structures are not automatically ineffective after TOSI, but they require a more careful review. 

The corporation should consider who owns each class of shares, whether any family member can satisfy the excluded shares exception, whether the corporation earns services income, whether it is a professional corporation, and whether dividends can be justified by work, capital, or risk. A share structure that was tax-efficient before 2018 may no longer produce the intended result if the recipients cannot support an excluded amount. (subsection 120.4(1))

Use properly structured related-party financing where the attribution rules can be avoided. 

For example, a loan to a spouse or related person may avoid attribution if it bears interest at the prescribed rate or a commercial rate and the borrower pays the interest no later than 30 days after the end of the year. 

This type of planning must be implemented carefully. The interest rate, written loan agreement, payment deadline, source of funds, and annual interest payments should all be documented. This is not a retroactive fix; if the interest is not paid within the required 30-day period, the attribution rules may apply. (subsection 74.5(2); Regulation 4301(c))

Consider fair-market-value transfers where property is sold to a spouse or common-law partner for full consideration

The attribution rules may be avoided where the purchaser pays fair market value for the property, and the transferor elects out of the subsection 73(1) rollover so that the transfer occurs at fair market value. 

This option requires careful valuation, proper payment terms, and correct tax reporting. It should not be treated as a simple paper transfer because the tax result depends on whether the transaction is implemented at fair market value and whether the required election is made. (subsections 74.5(1), 73(1))

Recognize that not all future income is automatically tainted merely because earlier income was split income

The rules were narrowed so that TOSI does not generally apply forever to all income earned from reinvested split income. This can be relevant where amounts previously taxed or received are reinvested and later generate new income. However, the source and connection of the later income should still be reviewed carefully, especially where the funds remain connected to a related business or private corporation structure. (section 120.4)

Review planning opportunities that arise on death or relationship breakdown. 

TOSI and the attribution rules contain relieving rules for certain death-related situations and for transfers or arrangements arising from the breakdown of a marriage or common-law partnership. 

These rules are not ordinary income-splitting tools, but they can materially affect the tax analysis in estate planning, succession planning, and family-law settlements involving private corporation shares or related property. (subsections 74.5(3), 74.5(4), 120.4(1), 120.4(1.1))

Review dividend policies before declaring dividends to family members

The key question is no longer whether a family member legally owns shares. The question is whether the payment can be defended under the TOSI framework. 

Before dividends are paid, the corporation should identify the recipient, the recipient’s age, the applicable exclusion, the work performed, the capital contributed, the risk assumed, the share rights, and the supporting documents. Where the existing structure does not support the intended payments, restructuring may be required before the corporation continues making distributions to spouses, adult children, or family trusts.

For accountants and owner-managers, the practical takeaway is that TOSI restructuring should be proactive, documented, and tailored to the facts. Salary planning, prescribed-rate loans, fair-market-value transfers, share-structure reviews, and excluded-amount analysis can all be useful, but only when implemented correctly. Where a CRA audit or tax reassessment challenges income splitting in a family-owned private corporation, advice from an experienced Canadian tax lawyer can be critical in determining whether the structure can be defended or should be reorganized.

“Many TOSI problems begin with a simple mistake: the family assumes that legal share ownership is enough. It is not. In a CRA tax audit, the question is not only who owns the shares, but why that person was entitled to receive the income without being taxed at the highest marginal rate. For family-owned corporations, the safest approach is to identify the TOSI exclusion before the dividend is paid and to keep the evidence that supports it. If the file does not show work performed, capital contributed, risk assumed, excluded shares, or another statutory basis for the payment, the income-splitting plan may fail when the CRA reviews it.” 

• David Rotfleisch, Certified Specialist In Taxation

Pro Tax Tips – Practical TOSI Planning for Family-Owned Private Corporations

TOSI planning should begin before dividends, trust distributions, shareholder benefits, or related-party payments are made. Once a CRA audit or tax reassessment has started, it is much harder to reconstruct the facts needed to support an excluded amount. 

Family-owned private corporations should therefore review their share structure, dividend policy, compensation arrangements, and family trust allocations before implementing income-splitting transactions.

1. Analyze TOSI on a recipient-by-recipient basis: A spouse, adult child, minor child, and family trust beneficiary may each be in a different position under section 120.4 of the Income Tax Act. The same dividend may be defensible for one family member but subject to TOSI for another. Before paying or allocating income, identify each recipient’s age, role in the business, share ownership, capital contribution, risk exposure, and available exclusion.
2. Do not assume that share ownership alone is enough: A family member who legally owns shares of a private corporation may still be subject to TOSI if the income does not qualify as an excluded amount. This is particularly important for family trusts, discretionary dividend shares, professional corporations, and other structures in which family members hold shares but do not work in the business, contribute capital, or assume meaningful risk.
3. Maintain contemporaneous evidence: The CRA will typically focus on the facts supporting the claimed exclusion. For the excluded business exception, taxpayers should retain records of hours worked, tasks performed, job duties, emails, calendars, payroll records, and evidence of regular involvement in the business. For a reasonable return, taxpayers should document labour, capital contributions, guarantees, property pledged as security, risks assumed, prior payments, and comparable compensation or investment returns.
4. Exercise caution with professional corporations: Professional corporations do not qualify for the excluded shares exception, so dividends paid to spouses, adult children, or other family members may require a different basis to avoid TOSI. In those cases, taxpayers may need to rely on excluded business, reasonable return, spousal age-65 relief, or another applicable exclusion. A professional corporation structured for income splitting before 2018 should be carefully reviewed under the current TOSI rules.
5. Consider whether salary is more appropriate than dividends: Salary and ordinary employment compensation are not subject to TOSI in the same way as dividends, but they must be reasonable under the Income Tax Act. Where a family member actually performs bookkeeping, administrative, management, marketing, technical, or operational work, reasonable salary may be more defensible than unsupported dividends. However, the corporation should document the services performed and the basis for the compensation.
6. Review family trusts carefully: A family trust may still be useful for estate planning, succession planning, creditor protection, or corporate reorganization purposes, but trust distributions can create TOSI issues. Trustees should not assume that all beneficiaries can receive income on the same tax basis. Each allocation should be reviewed separately, and trust records should identify why a particular beneficiary can receive the amount without triggering TOSI.
7. Revisit old structures: Many family-owned corporations still have share structures created before the 2018 TOSI expansion. These structures may include multiple classes of discretionary dividend shares, family trusts, holding corporations, estate freezes, or shares held by spouses and adult children. A structure that made sense before the expanded TOSI rules may no longer produce the intended tax result if the recipients cannot support an excluded amount.
8. Involve a top Canadian tax lawyer before the structure is challenged: TOSI disputes are highly fact-specific and often turn on documentation, statutory interpretation, and the implementation of the corporation’s legal structure. Where a family corporation has already paid dividends or allocated income to related family members, an experienced Canadian tax lawyer can help assess the risk, respond to CRA questions, prepare submissions, and determine whether the taxpayer’s position can be defended.

Frequently Asked Questions About TOSI and Family-Owned Businesses

Who is taxable on split income under the TOSI rules?

TOSI applies to a “specified individual” who receives split income. In general terms, the specified individual is the person who receives the income and may be subject to the highest marginal tax rate under section 120.4 of the Income Tax Act. In many family business structures, the specified individual is a lower-income spouse, common-law partner, child, or other related family member who receives income from a private corporation, trust, partnership, or related business.

What is a “source individual” for TOSI purposes?

A source individual is generally the related person whose business, ownership, or involvement creates the income-splitting concern. For example, if a parent operates a private corporation and dividends are paid to an adult child through a family trust, the parent may be the source individual and the adult child may be the specified individual. The relationship between the source individual, the specified individual, and the related business is central to the TOSI analysis.

What types of income can be split income?

Split income may include taxable dividends from private corporations, shareholder benefits, trust or partnership income connected to a related business, interest from certain private corporation or partnership debt, and certain capital gains involving private corporation shares, trust interests, or partnership interests. TOSI is therefore broader than a simple dividend rule. It can apply to several forms of income connected to a family-owned private corporation or related business.

Are salaries paid to family members subject to TOSI?

Salary and ordinary employment compensation are not subject to TOSI in the same way as dividends. However, salary must still be reasonable under the Income Tax Act. If a spouse, adult child, or other family member actually works in the business, reasonable salary may be a better planning option than unsupported dividends. The corporation should keep evidence of the work performed, hours worked, duties, market compensation, and payment records.

Are dividends from publicly traded shares subject to TOSI?

TOSI generally focuses on private corporation income-splitting structures, not ordinary dividends from publicly traded shares or mutual fund corporations. However, the analysis may change if publicly traded investments are held inside a private holding corporation and that holding corporation pays dividends on its own shares to related family members. In that case, the dividend is from the private corporation, and TOSI should be reviewed carefully.

How does TOSI apply to family trusts?

Family trusts can create TOSI issues when they receive dividends from a private corporation and allocate income to family beneficiaries. The TOSI analysis must be done beneficiary by beneficiary. One beneficiary may qualify for an excluded amount because they work in the business, while another beneficiary may be subject to TOSI because they have no labour contribution, capital contribution, risk exposure, or qualifying share ownership.

What is an excluded amount?

An excluded amount is an amount that would otherwise be split income but is removed from the TOSI regime because it falls within a statutory exclusion. Excluded amounts may include income from an excluded business, certain safe harbour capital returns, reasonable returns, amounts connected to excluded shares, certain death-related amounts, certain relationship-breakdown property, and certain gains eligible for the lifetime capital gains exemption. The key issue is whether the taxpayer can prove that the particular amount fits within the exclusion.

What is a related business?

A related business is generally a business connected to a related person who is actively involved in the business or has a sufficient ownership connection with the entity carrying on the business. This concept is important because, for adult recipients, TOSI often depends on whether the amount received derives directly or indirectly from a related business. If the income is not connected to a related business, TOSI may not apply. If it is connected, the recipient must look for an available exclusion.

What is a reasonable return under the TOSI rules?

A reasonable return is determined based on the facts. Relevant factors may include the work performed by the family member, property or capital contributed, risks assumed, prior amounts paid or payable, and other relevant circumstances. For example, a spouse who provides bookkeeping or administrative services, guarantees corporate debt, or pledges personal assets may have a stronger argument that a dividend reflects a reasonable return. The amount must still be supportable with evidence.

What should accountants and owner-managers do before paying dividends to family members?

Before paying dividends or allocating income through a family trust, accountants and owner-managers should identify each recipient, confirm the recipient’s age, determine whether the income is connected to a related business, and identify the specific TOSI exclusion being relied on. They should also gather supporting documents, including work records, shareholder registers, trust resolutions, loan agreements, guarantees, compensation comparisons, and capital contribution records. Where the structure is unclear or a CRA audit has started, advice from an experienced Canadian tax lawyer can be critical in defending the taxpayer’s filing position.

DISCLAIMER: This article provides broad information. It is only accurate as of the posting date. It has not been updated and may be out-of-date. It does not give legal advice and should not be relied on as tax advice. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.