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22nd Class_Income Splitting

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Vokhid Urinov

on 23 January 2018

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Transcript of 22nd Class_Income Splitting

Income Splitting: Basic concept
Attribution Rules: Basic Concept
Exceptions to Attribution Rules
Income splitting is a practice of a high-income taxpayer transferring income to a low-income taxpayer to reduce overall tax burden
Example: Income Splitting
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There is no longer an individual to receive attributed income (e.g. breakdown of marriage, ceasing to be a resident of Canada, or death)

Permitted Income Splitting
Deductions to spousal RRSP (s.74.5(12))
Spouse and CLP tax credit (s.118(1)(a))
Transfer of tuition and education amounts (s.118.8, s.118.81, s.118.9)
Pension income transfer (s.60.03)
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Attribution Provisions

Income Splitting
The transfer is usually to a person with whom the taxpayer forms an economic unit (e.g. spouse, CLP, or related minor)
Methods: transferring the ownership of the asset, extending a low or no interest loan, the assignment of right to income
The result: an overall lower tax leakage on the income
Suppose Jennifer owns a residential property which yields $80,000 income a year. She also earns $80,000 in employment income.
What would be tax implications if she transfers the ownership of the property to her husband, Robert, who has no income?
Transfers or loans to a spouse (s.74.1(1), s.74.2(1))

Transfers or loans to a minors (s.74.1(2))

Transfers or loans to a trust (s.74.1(1),(2); s.74.3)

Transfers and loans to a corporation (s.74.4)

Indirect payments (s.56(2))

Transfer of rights to another person (s.56(4))

Kiddie tax (s.120.4)

Contribution to spousal RRSP and withdrawal (s.146(8.3))

"Attribution rules" or ARs are designed to stop the taxpayers from splitting the income
ARs attribute the income back to the person who transferred it as if the transfer has never happened (for tax purposes)
Transfers and Loans to a Spouse (s.74.1(1), 74.2)
Applies to the transfers of income yielding property and loans to a spouse
The transfer includes a gift as well as a sale for a consideration less than FMV
Income earned from the transferred property, capital gains and capital losses, will be attributed to the spouse who transferred or loaned the property
Transfers and Loans to Minors (s.74.1(2))
Transfers of income-yielding property or loans to a related minor (i.e. a related person under 18)
Income earned from the transferred property will be attributed to the taxpayer who transferred or loaned the property
Related minor:
child, grandchild, brother, sister, niece, nephew
Kiddie Tax: Split Income
Kiddie tax rules subject certain income ("split income") earned by certain minors (under the age of 18) to the top marginal tax rate (i.e.33%)
Definition of "split income (s.120.4(1)):
Kiddie tax is not an attribution rule. It simply subjects the split-income to be taxed in minor's hands at top marginal rate (i.e.33%)
Progressivity of Individual Taxation
Each individual as a Tax Unit
Implications:

Families with identical income but with different tax burdens
Indirect Payments (s.56(2))
Common law tests (
Newman v. MNR
[1998]):
(A) The payment is to a person other than the taxpayer
She is at the top marginal tax bracket of 29%. Her overall tax burden on the income is $35,718 or effective tax rate of 22%.

Both Jennifer and Robert are at 22% marginal tax bracket with overall tax burden of $29,047 or effective tax rate of 18%.
ARs generally apply only to income or loss from property or loan extended by the taxpayer. ARs do not apply to business income
AR also does not apply to the "income from the income" of the transferred property"
The rule applies to "indirect transfers" and "back-to-back" loans
No capital gain or loss is attributable
Transfers and Loans to Trust (s.74.1, 74.3, 75(2))
Transfers of income-yielding property or loans to a trust established for the benefit of a spouse or minor
Income earned from the transferred property to a trust will be attributed to the taxpayer (i.e. settlor) who transferred or loaned the property
Example: Attribution of Capital Gain under s.74.2
Janice bought a rental property for $500,000 in 2011. The property yields $80,000 rental income annually. In 2014, Janice gives the property to her spouse, Mark, when FMV of the property reached $600,000. The property continues to yield the same amount of income, now to Mark. Janice sold the property for $650,000 in 2015
Discuss the timing of application of attribution rules to rental income and capital gains
For 2014, rental income of $80,000 is attributed to Mark but not the deemed capital gain (the rollover under s.73(1)). The capital gain is attributed to Janice in 2015, when it is sold
Where the income earned from the transferred property to a trust is not payable to a spouse, CLP, or related minor, there will be no attribution. The income is taxed in the trust at the top marginal rate
When the settlor reserves a right to revoke the trust, the attribution rules apply regardless of the beneficiaries (s.75(2))
Transfers and Loans to Family Corporation (s.74.4)
Transfers of income-yielding property or loans to a corporation where the transferor's spouse or related minor is "specified shareholder" (i.e.10% or more shares);
Income earned from the transferred property to the corporation will be attributed to the taxpayer who transferred or loaned the property. The purpose test applies.
The amount attributable to the transferor is a (prescribed) quarterly interest on the value of the property or loan regardless of whether the dividend has been paid or not.
The attribution rules do not apply to a "small business corporation"
Income Splitting: Transfer to a Spouse
Janice's income:
$80k+$80k=$160k (MTB: 29%)
(i.e. $35,718 or effective rate of 22%)
Janice Doctor
(Wife)
Mark (Husband)
Purchase
Residence
Hospital
$80,000 salary
$80,000 rental income
Transfer of Ownership
$80,000 rental income
x
Janice's income:
$80k (MTB: 22%), $14,523 (18%)
Mark's income:
$80k (MTB: 22%), $14,523 (18%)
$29,046
Janice's income:
$80k+$80k=$160k (MTB: 29%)
(i.e. $35,718 or effective rate of 22%)
Janice Doctor
(Wife)
Mark (Husband)
Purchase
Residence
Hospital
$80,000 salary
$80,000 rental income
Transfer of Ownership
$80,000 rental income
Janice's income:
$80k (MTB: 22%), $14,523 (18%)
Mark's income:
$80k (MTB: 22%), $14,523 (18%)
$29,046
Transfers and Loans to a Spouse (s.74.1, 74.2)
(B) The allocation is at the direction or with the concurrence of the taxpayer;
(C) The payment is for the benefit of the taxpayer or for the benefit of another person whom the taxpayer wished to benefit;
(D) The payment is included in the taxpayer’s income to the extent it would be if the payment or transfer had been made directly to the taxpayer
Agenda
Income Splitting (Action):
Concept
Examples
Attribution Rules (Reaction):
Concept
Transfer of property or loan to a spouse
Transfer of property or loan to a related minor
Kiddie tax


Indirect Payments (s.56(2))
Transfers at fair market value (s.74.5(1)) and loans at a commercial rate of interest (s.74.5(2)) are not subject to ARs
Business income is not subject to ARs
Kiddie Tax: Conditions & Mechanism
Taxable dividends from private corporation, whether received directly or through a trust or partnership
Capital gains that a minor realizes from a disposition of shares of private corporations to a person with whom the minor does not deal at arm's length
Income received from a partnership or trust where the income of the partnership or trust is derived from the business or providing property or services to:
A person related to the minor
A corporation in which the related person holds 10% share
A professional corporation in which the related person is a shareholder
Conditions:
the minor is a resident of Canada and has a parent who is a resident of Canada
Income or taxable capital gain is from a property inherited by the minor from a parent
Kiddie Tax: Exceptions
Kiddie Tax does not apply (s.120.4(1)):
Income or taxable capital gain is from a property inherited by the minor from anyone else
Reasonable remuneration to minors
Nether the minor or her parents are residents of Canada for the year
Does Canada allow income splitting?
Contribution to Spousal RRSP & Withdrawal
If the funds contributed by the taxpayer to the spouse's RRSP are withdrawn within 3 years of the contribution, all or part of the withdrawn amount will be taxed as income to the spouse who made the contribution (s.146(8.3))
The amount to be included is the lesser of:
The total of all contributions to the spousal RRSP by the contributing spouse in the year, or in one of the two immediately preceding taxation years, and
The amount withdrawn
Personal Taxation
Income Splitting: Transfer to a Spouse
Charlie's solo business:
Consulting architect
Corporate clients
Annual income of $300k
Income is subject to top marginal rate (i.e.33%)
$128k income tax paid
Charlie
Yolanda (Wife)
Stephen (12)
Claudia (20)
Children
Charlie's business clients
Charlie's incorporated business:
Consulting architect
Corporate clients
Annual income of $300k
Income is subject to top marginal rate (i.e.14.5%)
$43,5k corp tax paid
Dream Home
Inc
50 shares (Voting)
50 shares
(Non-voting)
100 shares
(Non-voting)
Dream Home Co:
50 Class A (Voting) shares
150 Class B (Non-voting shares)
Question: Is this tax planning legitimate?
Tax liability of Char., Yol., Step., Claud., in aggregate after the planning: $41,2k
$300k income in 2015
- $50k salary to Charlie
- $36k in corporate taxes
=$214k after tax amount
- $150k in dividends to Y, S, Cla.
= $64k in retained earnings
Attribution rules under
s.74.1 and 74.2 may apply
Indirect Payments (s.56(2))
Transfers of property or income to another person for the benefit of the taxpayer or for the benefit of the person to whom the taxpayer wishes to benefit
Common Law Exceptions to s.56(2):
Taxpayer has no pre-existing entitlement to the dividends
Taxpayer paid proper consideration for the shares
Source: Income Tax Ruling - 2016-0626781E5
Example: diversion of pay-cheque to a family member
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