Tax on Split Income (TOSI)

The tax on split income is the federal limit on income sprinkling: paying dividends or other amounts from a private business to family members in lower tax brackets. It originally applied only to minors and was extended to adults starting with the 2018 tax year. The rules are in section 120.4 of the Income Tax Act.

When TOSI applies, the individual's split income is taxed at the highest federal rate, 33% for 2026, instead of at graduated rates, and Ontario adds its own tax on split income, calculated on Form T1206. Only the dividend tax credit, the foreign tax credit and the disability tax credit can reduce it. The recipient pays the tax; the corporation is not penalized.

Split income includes amounts like these when they come from a related business:

• Taxable dividends on shares of a private corporation, and shareholder benefits under section 15
• Interest on debt of a private corporation, partnership or trust
• Partnership or trust income
• Taxable capital gains on disposing of private-company shares and certain other interests

Salary is not split income. The CRA states that section 120.4 does not apply to salary, although the salary must still be reasonable for the corporation to deduct it, as explained in salary vs. dividends.

A related business is, broadly, a business in which a relative of the recipient is actively engaged on a regular basis, or a corporation in which a relative owns shares worth at least 10% of the value of all its shares.

TOSI applies to individuals resident in Canada at the end of the year (or immediately before death). A child who is 17 or younger at the end of the year is covered only if a parent was resident in Canada at some time in the year. The exclusions available depend on the age the individual reaches in the year:

One rule sits outside the age bands. If a business-owner spouse or common-law partner is 65 or older in the year, amounts the other spouse receives are excluded whenever they would have been excluded in the owner's hands.

From the year they turn 18, a family member is excluded for amounts derived from an excluded business: a business in which they were actively engaged on a regular, continuous and substantial basis in the current year or in any five prior years, which need not be consecutive.

The Act deems someone actively engaged if they work in the business an average of at least 20 hours a week during the part of the year the business operates, so a seasonal business is measured only over its season. Below 20 hours, the question depends on the facts. Once a person has five qualifying years, the exclusion stays available for that business, which protects a retired spouse or parent who helped build the company.

This test does not depend on share class or the type of business. It works for professional corporations, service businesses and non-voting discretionary dividend shares, as long as the work is real. Keep evidence of it, such as timesheets, calendars and a description of the role.

From the year they turn 25, dividends and capital gains on excluded shares are excluded. Shares qualify only if all of these are true:

• The individual owns shares carrying at least 10% of the votes and at least 10% of the fair market value of all issued shares of the corporation.
• Less than 90% of the corporation's business income in its last taxation year came from providing services.
• The corporation is not a professional corporation.
• All or substantially all of the corporation's income is not derived from a related business other than its own.

This is where share structure matters. Non-voting or discretionary dividend shares fail the votes test however much value they carry. Voting shares can fail the value test after an estate freeze puts most of the value in the founder's preferred shares. Consulting, staffing and other service businesses cannot use the test at all, and holding company shares can fail where the holdco's income is dividends from the family operating company. Our guide to share structure for a new Ontario corporation explains how classes are set up; run the TOSI analysis before shares are issued, not after dividends are paid.

Reasonable return (25 or older). An amount is excluded if it is reasonable having regard to the work the individual performed, the property they contributed, the risks they assumed, the amounts already paid to them and any other relevant factor. It is a judgment call that the CRA can dispute, so it works best as a backup to a clearer exclusion. The CRA's guidance on the split income rules for adults works through examples.

Ages 18 to 24. The return test looks only at capital. An amount is excluded if it is a reasonable return on arm's-length capital (capital that was not borrowed, not received from a related person other than by inheritance and not earned from the related business), or if it does not exceed a safe harbour capital return: the highest prescribed interest rate in effect during the year applied to the value of property the individual contributed.

Professional corporations. Excluded shares are never available, so dividends to a spouse or adult child who is not the professional generally rely on the excluded business test, a reasonable return or the 65-plus spouse rule.

Holding companies and family trusts. Routing dividends through a holding company or a family trust does not change the result, because TOSI reaches amounts derived directly or indirectly from the related business. Factor this in when deciding whether incorporating instead of staying a sole proprietor will actually save tax.

Ahmed Malik owns all the voting common shares of Malik Kitchen Supply Inc., a Mississauga distributor that sells commercial kitchen equipment rather than services. He has worked full-time in the business for twenty years. His wife, Sara, aged 52, holds 100 non-voting Class B shares she subscribed for at $1 each, and she has never worked in the business.

In 2026 the board pays Sara a $60,000 dividend. None of the exclusions fit: she has no history of work in the business, her non-voting shares fail the 10% votes test, and a $60,000 return on $100 of capital is not reasonable. The whole dividend is split income, taxed at the top federal and Ontario rates less the dividend tax credit instead of at her low brackets.

Ahmed turns 65 in 2027. From that year, dividends Sara receives are excluded if they would have been excluded in Ahmed's hands, and his decades of full-time work make the business an excluded business for him. Their accountant recommends holding Sara's dividends until 2027. For 2027 she also takes over the company's bookkeeping, and the corporation pays her a $28,000 salary for it. Salary is not split income at all; it only needs to be reasonable for the work so the corporation can deduct it.