Anonymised, illustrative composite. Equal shares looked fair on the cap table. The Income Tax Act was going to judge each sibling’s dividend on its own.
At a glance
A founder of a plastics injection-molding component manufacturer, valued at $6,000,000, had three adult children: two worked full-time in the business, and one — a physician with no history in the company — had never worked there at all. The founder wanted an equal, three-way transfer: $2,000,000 of value to each.
The intergenerational transfer relief under ITA s.84.1(2.31) turned out not to be the obstacle. Paragraph (b)(ii) requires the purchaser corporation to be “controlled by one or more children…each of whom is 18 years of age or older,” and paragraph (f)(ii) requires only that “the child, or at least one member of the group of children, as the case may be, is actively engaged on a regular, continuous and substantial basis…in the activities of a relevant business” for the 36 months after the disposition. Not all of them. With two of the three children clearly meeting that test, the third could have held shares in the same purchaser corporation and the rollover relief would still have applied, riding on her siblings’ engagement rather than her own. The obstacle was what happened after closing, the first time a dividend was paid — and it turned on which corporation’s shares she held.
ITA s.120.4, the tax-on-split-income rules, add “the highest individual percentage for the year multiplied by the individual’s split income” to a specified individual’s tax payable — the top marginal rate, applied to the whole amount, not a slice above some threshold. The out, for an individual who has “attained the age of 24 years before the year,” is an “excluded share.” The definition in s.120.4(1) sets three conditions, and the file the accountant first prepared tested two of them. Paragraph (a) requires that “less than 90% of the business income of the corporation…was from the provision of services” and that the corporation is not a professional corporation. Paragraph (b) requires the individual to own shares giving “10% or more of the votes” and having “a fair market value of 10% or more of the fair market value of all of the issued and outstanding shares.” Paragraph (c) — the one nobody had read — requires that “all or substantially all of the income of the corporation…is income that is not derived, directly or indirectly, from one or more related businesses in respect of the specified individual other than a business of the corporation.”
Every one of those three is a test about the corporation whose shares she owns. On the original plan that corporation was the purchaser corporation — a holding company whose only income would be dividends flowing up from the manufacturer. Paragraph (b) was fine: a third of the company is 33.3% of votes and value. Paragraph (a) looked fine only because a holding company has no service income, and no business income of any kind. Paragraph (c) was fatal. Her brothers are actively engaged in the manufacturer’s business, which makes it a related business in respect of her, and a holdco’s dividend income is derived indirectly from exactly that business rather than from a business of the holdco itself.
Qualifying for the s.84.1 rollover and qualifying for excluded-shares treatment are two separate tests, checked against two separate provisions, and one does not imply the other. The two active children clear TOSI a different way entirely — the “excluded business” route, since s.120.4(1.1)(a) deems an individual actively engaged where they work “at least an average of 20 hours per week during the portion of the year in which the business operates.” That is the same standard s.84.1(2.31)(f)(ii) borrows by express cross-reference, which is why the two children satisfy both provisions with one set of facts. The physician could never meet it. Her shares had to clear the excluded-shares route instead — and what decided whether they could was not her ownership percentage, which was never in doubt, but which corporation issued them.
All three children ended up with an equal one-third of the value, but not all through the same corporation. The two active children took the purchaser corporation that acquired the founder’s shares under s.84.1(2.31). The physician’s third was transferred to her by the founder directly — a disposition to an individual, outside s.84.1 altogether, which applies only to a disposition of shares to a corporation. The corporation whose shares she owns is therefore the manufacturer itself: it derives well under 90% of its business income from services, it is not a professional corporation, she holds 33.3% of its votes and value, and its income is its own manufacturing income rather than income derived from someone else’s related business. All three paragraphs are satisfied on their own terms, and dividends on her stake are taxed at her own marginal rate like any other shareholder’s.
Had the accountant assumed that qualifying for the s.84.1 rollover settled the tax question and not separately tested the physician’s shares, the first dividend paid on her stake would have told a different story. Say the company paid $80,000 to her in year one: s.120.4 taxes split income at the top rate on the full amount, not an excess over some threshold, so all $80,000 — not a portion of it — would have been taxed as if she were in the highest bracket, regardless of her actual income as a part-time physician. Confirming excluded-shares status before the first dividend, rather than after, is what kept that $80,000 taxed as ordinary shareholder income instead — and the confirmation that mattered was not about her, or her percentage, but about which corporation’s shares she was about to be issued.
The tell is assuming identical percentage stakes mean identical tax outcomes. They do not: three siblings holding the same one-third of the same company can land in completely different positions on the very first dividend, purely on whether each one, individually, works in the business. Every family member’s shares need their own excluded-shares or excluded-business test run separately — not once for the family as a group.
A 30-minute call can tell you whether every family shareholder in your succession plan clears TOSI on their own.
