The tax-on-split-income (TOSI) rules in Section 120.4 of the Income Tax Act sharply limit Canadian business owners' ability to share income with family members in lower tax brackets. The default rule applies top marginal personal tax rates to dividends paid from a related business to most family members. The exceptions — when family-member dividends ARE allowed at the recipient's normal rate — are the planning value.
The default rule
TOSI applies at top marginal rates to "split income" received by a "specified individual" from a related business. The default is broad: any dividend (or certain other passive income types) received by an adult family member from a corporation related to the principal shareholder is split income unless an exception applies.
"Specified individual" includes the principal shareholder's spouse, common-law partner, children, parents, siblings, and grandchildren. "Split income" includes dividends, capital gains in certain circumstances, debt-interest from a related business, and income from a partnership related to the business.
The tax impact is significant: a dividend that would normally be taxed at the recipient's marginal rate (potentially as low as 6-10% for adult children in low brackets) is instead taxed at the top marginal rate (~53.5% in Ontario for non-eligible dividends). For income-splitting strategies that depend on bracket arbitrage, TOSI eliminates the benefit.
The exceptions
The exceptions to TOSI are the planning hooks. The most useful in practice:
1. Excluded business exception. Available to a family member who works in the business an average of 20 hours per week during the year (or during one of the five preceding years). The exception is binary — at 20 hours/week, the family member's dividend isn't split income; below it, the dividend is. Documentation matters: time sheets, calendar logs, board-meeting minutes, anything that shows the 20-hour threshold being met.
2. Excluded shares exception. Available to a family member aged 25+ who owns at least 10% of the votes and value of the corporation AND the corporation is not (i) a service business that earns more than 90% of its income from services or (ii) a related-party business. The 10% threshold is the trap — many family-trust structures end up with family members owning growth shares that don't meet the 10% direct-ownership test.
3. Reasonable return exception. Available to a family member aged 25+ who receives a "reasonable return" relative to their actual contributions to the business — labour, capital invested, risks assumed, historical contributions. The test is multi-factor and CRA-discretion-dependent. Useful for adult children who put in real work or capital but don't meet the 20-hour test.
4. Age 65+ exception (for spouses). A spouse aged 65+ can receive dividends sourced from the principal shareholder's active business without TOSI applying. The exception lets retiring owner-managers split income with their spouse during the pre-retirement and retirement years.
5. Excluded amount exceptions. Certain specific receipts are excluded from TOSI: gains on dispositions of qualifying small-business-corporation shares to a third party, certain Inheritance receipts, return of capital from registered plans, and a few others.
The trust complication
For family discretionary trusts that hold growth shares of a corporation, the TOSI analysis runs through to each beneficiary. A trust allocating capital gains or dividends to a beneficiary is treated as if the beneficiary directly received them from the underlying corporation. The beneficiary's TOSI position is what matters — not the trust's.
The implication: when designing an income-splitting trust structure, the trustees should know which beneficiaries can receive allocations without TOSI applying each year. The mix changes as kids age into the 25+ exceptions, as employment status shifts, as the principal shareholder ages into the 65+ spouse exception.
The 24-month look-back
The "excluded business" exception (20 hours/week) is available not only when the family member works that much in the current year — it's also available if they worked 20 hours/week in any of the five preceding years. This is useful for family members who were full-time in the business and have since reduced their hours: they qualify under the 5-year look-back for the years immediately after retirement.
What's a "related business"?
The relatedness test is broad. It catches:
- Corporations in which the principal shareholder or a related person has a significant interest.
- Partnerships, trusts, and other entities controlled by the family.
- Service businesses where related parties are the principal customers.
For most owner-managers, the family corporation is unambiguously a related business and TOSI applies by default.
Planning around TOSI
Effective TOSI planning is exception-driven:
- Engage family members in real roles — adult children who work 20+ hours/week qualify under the excluded-business exception.
- Restructure share ownership for the 10% test — adult family members directly owning 10%+ of voting shares can qualify under the excluded-shares exception (subject to the service-business restriction).
- Time distributions to use the 65+ spouse exception — retirement-phase income splitting between a younger principal shareholder and a 65+ spouse is fully allowed.
- Pay reasonable return on real capital invested — adult family members who lent the business capital or otherwise contributed can receive returns under the reasonable-return exception.
How we work the file
TOSI screening is part of every annual owner-manager-compensation review at Barrett Tax Law. We screen each proposed dividend or trust allocation against the exceptions, document the qualification, and brief the corporate accountant for the year-end work. The cost of screening is far less than the tax cost of an incorrect distribution.