Corporate Attribution

Income splitting is an effective tax planning tool to take advantage of the different marginal personal income tax rates at different income levels. By splitting income amongst individual family members, tax savings results by taking advantage of multiple lower personal tax bracket rates. Click HERE for tax rates at various personal income levels.

There are tax rules to prevent excess income splitting. General attribution rules are discussed HERE and some tax planning to avoid attribution is discussed HERE. In those discussions, it was assumed that income splitting involved individuals directly. However, there are also tax rules to prevent the same sort of income splitting indirectly, through the use of corporations and are found in Section 74.4 of the Income Tax Act.

Section 74.4 extends the general attribution rules to certain situations where an individual has transferred or loaned property to a corporation, other than a Small Business Corporation, either directly or indirectly by means of a Trust or any other means and one of the main purposes of the transfer or loan may reasonably be considered to reduce the income of the individual who loaned or transferred the property and to benefit directly or indirectly a person who is a Designated Person who is a Specified Shareholder of the corporation. A Designated Person is the individual's spouse, a person who is non-arm's length who is under 18 years of age, and a nephew or niece who is under 18 years of age. A Specified Shareholder is defined as a person who owns directly or indirectly 10% or more of the issued shares of any class of the corporation at any time during the year. 

If Section 74.4 applies, then the individual receives a taxable interest benefit each year. The calculation of the benefit is very complex as follows:

1. In the case of transfer of property, the fair market value of the property, less at the time of transfer the fair market value of non-excluded consideration received by the transferor, multiplied by the prescribed rate during the period. From this result is subtracted 5/4 of any taxable dividend the Transferor receives during the year on shares received as consideration for the transfer. Excluded consideration is defined as indebtedness or a share of the corporation (or rights to receive indebtedness or shares). 

2. In the case of loans or money, the principal amount of the loan or amount of money less the fair market value of any repayment other than a repayment which is excluded consideration multiplied by the prescribed rate during the period. From this result is subtracted the amount of interest received by the transferor in respect to the loan. Excluded consideration is defined as indebtedness or a share of the corporation (or rights to receive indebtedness or shares). 

Here is a simple example of the calculation of the benefit:

On July 1, 1988 an individual transfers property having a fair market value of $120,000 to a corporation that is not a small business corporation in exchange for preferred shares of the corporation. The sole holder of common shares of the corporation is the individual's spouse. On December 1, 1988 the corporation pays a dividend of $3000 to the individual and the prescribed rate of interest is 10%.

Assuming that the transfer was made for the purpose of reducing the income of the individual and of benefiting the individual's spouse, the amount that is attributed to the individual under section 74.4 for the 1988 taxation year is $2,250 calculated as follows:

On July 1, 1988 an individual transfers property having a fair
market value of $120,000 to a corporation that is not a small business
corporation in exchange for preferred shares of the corporation. The sole
holder of common shares of the corporation is the individual's spouse. On
December 1, 1988 the corporation pays a dividend of $3,000 to the individual
and the prescribed rate of interest is 10%.

Assuming that the transfer was made for the purpose of reducing
the income of the individual and of benefiting the individual's spouse,
the amount that is attributed to the individual under section 74.4 for the
1988 taxation year is $2,250 calculated as follows:

The amount by which

$6,000 (the amount of the loan outstanding ($120,000) multiplied
by the prescribed rate of interest (10%) and the relevant
period of time 1/2 year))

exceeds

$3,750 (5/4 of $3,000, the dividends received on excluded consideration)

= $2,250.

There are tax planning opportunities to mitigate or avoid these attribution calculations HERE. Careful tax planning with a Chartered Accountant is necessary. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

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