When the government replaced the income splitting rules for private corporations, they could have made it simple. Instead, the new package is complex and pages are filled with the new rules, lengthy definitions and exemptions to the rules. Basically what the new rules now require is that family members prove that their contributions to the family business are meaningful enough to get the dividends they receive. If they can’t, then the dividend income will be subject to punitive tax rates. If a company earns less than 90 percent of its income from a service business, the rules will not apply to certain family members. Since most of Canadian small businesses are service providers, they do not qualify for these exemptions.
- Income splitting involves diverting dividend income (and certain other types of income) from one family member to another member in a lower tax bracket.
- Under the new rules, family members over age 24, who work less than 20 hours per week may have to prove that their contributions to the business are reasonable.
- Some of the factors for work to be considered reasonable are: work performed, property contributed, risks assumed and any other “relevant factors,” in addition to this being compared with contributions made by their relatives.
“In short, it means that many family members — of all ages — now have to convince the tax authorities that their contributions to the family business are meaningful enough to justify the dividends they receive. Otherwise, they risk punitive tax rates on the dividend income.”