November 23, 2024
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The Income Tax Act contains rules to prevent income-splitting arrangements between family members and other non-arm's length persons. One of these rules, referred to as the Kiddie Tax, limits income-splitting techniques that seek to shift certain types of income to a non-arm's length minor. Prior to the March 2011 Federal Budget, the Kiddie Tax generally applied to taxable dividends and shareholder benefits from private corporations and certain income from a partnership or trust. The Kiddie Tax rules tax this type of income at the high marginal rates regardless of the minor's actual marginal tax rate. Prior to the Kiddie Tax rules it was possible to significantly reduce the effective combined corporate and personal tax levied on business income by paying dividends out of after-tax corporate earnings to shareholders who were minors. These shareholders, who often had little or no other income, would pay little or no tax on such dividend because of the available personal and dividend tax credits. As a result, in many cases, only corporate level tax was paid on business income which was usually subject to the small business deduction. In Ontario, for example, an individual can earn as much as $50,000 of eligible dividends, tax free, if the person has no other income. The Kiddie Tax makes these dividends fully taxable. Prior to the March 2011 Federal Budget, the Kiddie Tax did not apply to capital gains so structures were developed to convert dividends into capital gains. Effective after March 22 2011 the Kiddie Tax rules have been expanded to eliminate this type of planning. After March 22, 2011 capital gains realized by, or included in the income of, a minor from a disposition of shares of a corporation to a person who does not deal at arm's length with the minor, will be subject to the Kiddie Tax, if taxable dividends on the shares would have been subject to the tax. Capital gains that are subject to this measure will be treated as dividends and will not benefit from the lower capital gains inclusion rate or the lifetime capital gains exemption. While the rules should not apply to dispositions to an arm's length third party they would appear to apply to crystallization transactions where capital gains are realized in order to utilize a minor's capital gains exemption. The rules seem to also apply on a sale of shares to a sibling even if the transaction is for legitimate reasons. It should be noted that the Kiddie Tax rules do not apply to capital gains on publicly traded shares or on the sale of shares of a private corporation to an arm's length person. TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes. |