TOSI Explained for Vancouver Owner Managers: Paying Family From Your Corporation

Tax on Split Income (TOSI) rules significantly impact how Canadian business owners can pay family members from their corporations. Since 2018, these rules have restricted income splitting strategies that were once common. This guide explains TOSI in plain English, shows you how to qualify for exemptions, and helps you structure family compensation legally and tax-efficiently.

What Is TOSI and Why It Matters

Tax on Split Income (TOSI) is a special tax rate applied to certain types of income received by family members from a related business. Instead of being taxed at their personal marginal rate, TOSI income is taxed at the highest federal rate (33%), eliminating the tax benefit of income splitting. TOSI applies to dividends, shareholder benefits, and some partnership income paid to spouses, children, and other related persons.

When TOSI Applies: The Basic Rules

TOSI applies when a family member receives income from your corporation and doesn’t meet certain exemption tests. Understanding these triggers helps you structure compensation correctly:

Dividends to Spouses

Dividends paid to your spouse are subject to TOSI unless your spouse meets the excluded business or excluded shares test. This is the most common TOSI trigger.

Dividends to Adult Children

Dividends to adult children (18+) are subject to TOSI unless they meet the excluded business test or the income is reasonable based on their contributions.

Shareholder Benefits

Benefits provided to family members (like personal use of company assets) may be subject to TOSI if they’re considered split income.

Partnership Income

Income from partnerships where family members are partners may be subject to TOSI if they don’t meet the excluded business test.

Important: TOSI applies at the highest federal tax rate (33%), plus provincial tax. This can result in effective tax rates of 45% or higher, eliminating any tax benefit from income splitting. Always verify exemption status before paying family members.

The Excluded Business Test: Your Primary Defense

The excluded business test is the most important exemption from TOSI. If a family member meets this test, their income from your corporation is not subject to TOSI. Here’s how it works:

Excluded Business Requirements

A family member’s income is from an “excluded business” if they are actively engaged in the business and meet one of these conditions:

5-Year Test: They worked at least 20 hours per week in the business during the current year and in at least 5 of the previous 10 years.

Current Year Test: They worked at least 20 hours per week in the business during the current year and the business earned less than 90% of its income from providing services or property to related businesses.

Key Point: “Actively engaged” means the family member must be involved in the day-to-day operations, not just a passive shareholder. CRA looks at actual work performed, not just job titles. Documentation is critical to prove active engagement.

The Excluded Shares Test: For Spouses Only

The excluded shares test is another exemption available only to spouses. If your spouse meets this test, dividends from excluded shares are not subject to TOSI:

Excluded Shares Requirements

Shares qualify as “excluded shares” if they meet all of these conditions:

Less than 10% Ownership: The corporation has fewer than 10 full-time employees (or equivalent) throughout the year.

Not a Professional Corporation: The corporation is not a professional corporation (law, medicine, accounting, etc.).

Not Service Income: Less than 90% of the corporation’s income comes from providing services or property to related businesses.

Spouse Ownership: Your spouse owns shares representing at least 10% of the votes and value of the corporation.

Reasonableness Factors: When Income Is “Reasonable”

Even if a family member doesn’t meet the excluded business or excluded shares test, their income may still avoid TOSI if it’s considered reasonable based on their contributions. CRA considers these factors:

Time Spent

How many hours per week/month the family member actually works in the business. Part-time work typically justifies part-time compensation.

Skills and Expertise

The family member’s qualifications, experience, and specialized knowledge. Higher skills justify higher compensation.

Market Rates

What you would pay an unrelated third party for similar work. CRA compares your family compensation to market rates.

Business Impact

The value of the family member’s contributions to business success. Revenue generation, client relationships, and operational efficiency matter.

Documentation to Keep: Proving Your Case

If CRA audits your TOSI situation, you’ll need documentation to prove exemptions or reasonableness. Keep these records:

Time Sheets: Detailed records of hours worked by family members, including dates, tasks performed, and time spent.

Job Descriptions: Written job descriptions outlining roles, responsibilities, and required skills for each family member.

Employment Contracts: Formal employment agreements specifying compensation, hours, and duties for family employees.

Market Rate Research: Documentation showing what similar positions pay in your industry (job postings, salary surveys, etc.).

Performance Reviews: Annual reviews documenting contributions, achievements, and value added by family members.

Board Minutes: Corporate minutes documenting decisions, roles, and compensation arrangements for family members.

Salary vs Dividends: Which Is Better for Family Members?

The choice between salary and dividends for family members depends on TOSI status, tax rates, and business needs. Here’s a comparison:

Factor

Salary

Dividends

TOSI Risk

No TOSI risk (salary is always reasonable if market-based)

TOSI risk if excluded business/shares tests not met

Tax Rate

Taxed at personal marginal rate (up to 53.5% in BC)

Eligible dividends: ~39% (if no TOSI); TOSI: ~45%+

RRSP Room

Creates RRSP contribution room

No RRSP room created

CPP/EI

CPP contributions required; EI if insurable

No CPP/EI contributions

Business Deduction

Deductible expense (reduces corporate tax)

Not deductible (paid from after-tax income)

Recommendation: For family members who don’t meet excluded business/shares tests, salary is usually safer because it avoids TOSI risk entirely. Even if dividends have a slightly lower tax rate, the TOSI risk often outweighs the benefit. Consult with a tax professional to model both options for your specific situation.

Common Mistakes That Trigger TOSI Reassessments

Avoid these common errors that lead to TOSI reassessments and penalties:

Paying Dividends Without Testing

Paying dividends to family members without first verifying they meet excluded business or excluded shares tests. Always test before paying.

Insufficient Documentation

Failing to document hours worked, job duties, and market rates. Without documentation, you can’t prove excluded business status or reasonableness.

Overstating Hours Worked

Claiming family members work 20+ hours per week when they don’t. CRA audits time records and will disallow if hours are inflated.

Ignoring Reasonableness

Paying excessive dividends that don’t align with actual contributions. Even if excluded business test is met, unreasonable amounts may be challenged.

Not Updating When Business Changes

Failing to reassess TOSI status when business grows, adds employees, or changes operations. What was excluded may no longer qualify.

Mixing Personal and Business

Allowing family members to use company assets personally without proper documentation. This can trigger TOSI on shareholder benefits.

Sample Scenarios: Real-World Examples

Here are practical examples showing how TOSI applies in different situations:

Scenario 1: Spouse Meets Excluded Business Test

Situation: Your spouse has worked 20+ hours/week in your consulting business for 6 years. You want to pay $50,000 in dividends.

Analysis: Spouse meets the 5-year test (worked 20+ hours/week in 6 of last 10 years).

Result: ? No TOSI – Dividends are from an excluded business. Safe to pay dividends.

Scenario 2: Spouse Doesn’t Meet Tests

Situation: Your spouse owns 15% of shares but only works 5 hours/week. You want to pay $30,000 in dividends.

Analysis: Spouse doesn’t meet excluded business test (< 20 hours/week) and corporation has 12 employees (fails excluded shares test).

Result: ? TOSI applies – Dividends taxed at ~45%. Better to pay salary instead.

Scenario 3: Adult Child with Reasonable Salary

Situation: Your 25-year-old child works 15 hours/week doing bookkeeping. You pay $25,000 salary.

Analysis: Salary is reasonable based on hours and market rates for part-time bookkeeping ($32/hour × 15 hours/week × 52 weeks ? $25,000).

Result: ? No TOSI – Salary is always exempt from TOSI if reasonable. This is the safest approach.

Scenario 4: Adult Child Receiving Dividends

Situation: Your 22-year-old child owns 10% of shares, works 25 hours/week, but only for 2 years. You pay $20,000 dividends.

Analysis: Child doesn’t meet 5-year test yet, but works 20+ hours/week and business earns < 90% from related services.

Result: ? No TOSI – Meets current year excluded business test. Dividends are safe, but document hours carefully.

Action Checklist Before Year End

Use this checklist to ensure TOSI compliance before paying family members:

Verify each family member’s hours worked (need 20+ hours/week for excluded business test)

Check if spouse meets excluded shares test (if applicable)

Document all hours worked, job duties, and contributions for each family member

Research market rates for similar positions to justify compensation levels

Decide whether salary or dividends are better for each family member

Create or update employment contracts and job descriptions

Set up time tracking systems if not already in place

Review business structure (employee count, service income %) for excluded shares test

Critical: TOSI rules are complex and penalties for non-compliance are severe. If you’re unsure about your situation, consult with a tax planning professional before making compensation decisions. A professional can help you structure payments legally and optimize tax outcomes.

Book a TOSI Risk Review

TOSI rules are complex and getting them wrong can result in significant tax penalties. J. Wang Chartered Professional Accountant offers TOSI risk reviews to help Vancouver business owners understand their exposure, verify exemption status, and structure family compensation correctly. We’ll review your situation, test excluded business/shares qualifications, and recommend the safest compensation strategy.

TOSI Risk Assessment

Exemption Testing

Compensation Strategy

Documentation Review

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