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CRA’s Attribution Rules

Background:

  • I’m a senior developer working full-time in a famous IT company, with a $360,000 annual salary which gives me only $17k monthly net income because of the Canadian tax brackets system
  • My wife has no income

Scenario 1:
I got a $17K year-end bonus, after tax it’s $10k in cash. I gave it to my wife and said: honey please go buy some Apple stocks. She did, and since the stock value of Apple doubles itself in a year, my wife sold the stock.

Scenario 2:
I got the $10K cash as a year-end bonus and gave it to my wife: honey please go do some investment. She went to buy the Apple stock, made some money, sold the Apple stock, then she uses the proceedings to buy Tesla stock, sold the Tesla stock and made another good fortune.

Scenario 3:
I got the $10K cash as a year-end bonus and gave it to my wife: honey please reward yourself with a big Louis Vuitton purse. She didn’t buy the purse. Instead, she uses the money in stock investment and makes some good capital gain.

Alright. In Scenario 1, even if the gain on Apple stock is reported by the wife, CRA will quote Income Tax Act Div-B SubDiv-F 74.1 and say: The source of the funds comes from the husband, so the husband is the actual beneficiary of the stock investment, thus due to the “Attribution Rule”, the gain from the stock proceeding goes back to the husband. Consequently, the tax rate of the husband is much higher.

In Scenario 2, according to the “Substituted Property principle” of Div-B SubDiv-F 74.2 of the Income Tax Act, not only the gain from Apple stock will be taxed on the husband, but also the gain from Tesla is also going back to the source of the fund, the husband.

In Scenario 3, the wife took the money that already belonged to her and invested in the stock market, and all subsequent gains could be counted on her own, which lowers the tax rate significantly.

Well, you must have thought of the solution to the above scenarios 1 and 2. That is exactly Scenario 3.

Now let’s go back to the academic theory: just because Canada has a progressive (or “graduate”) tax brackets system which imposes that the more money you make, the higher the percentage of tax you pay, the TOSI (Taxes on Split income) is therefore derived:

  • From the perspective of a family, higher income maker always hopes to share their income to lower income maker
  • From CRA, it is necessary to put a big stop sign on the TOSI

However, the above is just CRA’s requirements in theories. In real life, for example, when a couple with uneven incomes bought an investment property together, I have never seen CRA coming to the front door with the statement that the couple cannot have 50/50 on the title of the property because one party might contribute more.

However there is another however, starting in 2018, CRA began to put a simple yes/no question in every Canadian’s individual tax returns:

Does your income involve TOSI?

If you, the lower income maker, ever answer “yes” with a checkmark, your income will be automatically taxed at the highest tax rate which means more than half of what you make goes to CRA.

Since then, all kinds of blogs from accountants and lawyers to study TOSI’s restrictions have surfaced on the Internet. The strategies can be summarized into the following groups:

  • For your own small business, you can pay your family members salaries. This is the most common and reasonable practice. But since it is a salary, the person who earns the salary must have an actual job, or at least when the CRA comes to you for a payroll audit, you can easily come up with a log to prove the employee’s working details.
  • Your private company can distribute dividends to your family members, but this approach comes at a price. The company needs to pay CRA more $1K+ CPP per year. The specific working requirements for the family members are clearly provided on the canada.ca site such as at least 20 hours per week during the year.
  • Kiddie Tax: sometimes people transfer their assets that could generate income to the minors of the family. CRA has very detailed regulations on Kiddie Tax which can be found in the Income Tax Act Sub-Div-A 120.4.
  • Use a trust, namely a “revocable trust” as a separate entity to share the income. This is an advanced practice and it is recommended to consult with your accountant to see if it could work for you efficiently before you dive in.