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Effect of Holding Companies on Split Income
Holding companies are a popular way for entrepreneurs to organize their businesses, offering flexibility, asset protection, and tax planning opportunities. But involving your spouse in a holding company can lead to unexpected challenges, especially when it comes to income splitting and the Tax on Split Income (TOSI) rules.
Let’s break down how holding companies interact with split income rules, why including your spouse in the mix might backfire, and what you can do to make smart decisions about your corporate structure.
What Are Holding Companies?
A holding company is a corporation set up to hold shares of other companies, investments, or assets. Unlike operating companies, holding companies don’t run day-to-day business activities; rather, they own equity in one or more operating entities.
This setup can have some significant advantages:
- Asset protection: Keeps valuable assets away from business risks.
- Tax deferral: Allows dividends to move between corporations tax-free until you take them out personally.
- Ownership flexibility: Makes transferring shares to family members or a family trust easier.
While these benefits are definitely a huge plus, they also come with their share of caveats, especially under the TOSI rules.
The Impact of TOSI on Income Splitting
Income splitting has long been a go-to strategy for reducing household taxes and dividing income among family members in lower tax brackets. This all changed in 2018 when TOSI rules threw a wrench into things by tightening restrictions and targeting income deemed to be unfairly split.
Under these new rules, dividends paid to family members, such as a spouse, might be taxed at the highest marginal rate unless specific exceptions apply.
The CRA looks at a few key factors to determine if a spouse’s income qualifies:
- Are they actively involved in the business?
- Have they contributed through labour, capital, or other support?
- Does their ownership stake match their contributions?
Why Including Your Spouse in a Holding Company Can Backfire
While adding your spouse to a holding company might seem appealing and look like a smart way to share income, it’s not always that simple.
Dividends Could Trigger TOSI
If your spouse doesn’t actively contribute to the business, any dividends they receive could fall under TOSI rules. Instead of saving on taxes, you’d be hit with the highest marginal tax rate.
Limited Exceptions for Spouses
The TOSI rules offer a few exceptions, like when the business owner is over 65 or the spouse has a significant ownership interest and meets specific criteria. But outside these narrow cases, dividends paid to a spouse rarely qualify for exemptions.
Added Complexity, No Real Benefit
Including a spouse in your holding company could make your corporate structure unnecessarily complicated. This complexity often leads to higher legal and accounting costs without providing meaningful tax advantages.
How We Can Help
At Mowbrey Gil, we specialize in helping business owners navigate the complexities of corporate tax planning. Whether you’re looking to restructure your holding company or need clarity on TOSI rules, our team of chartered professional accountants is here to support you.
Give us a call at 780.461.3800 to ensure your corporate structure works for you, not against you.
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