Income splitting: not as easy as you think.

• Author: Kirby, Richard
• Position: Tax

As a general rule, transfers of property between spouses occur on a tax-free basis unless the spouses elect otherwise; in tax circles this is referred to as a "spousal rollover". Property is often transferred between spouses to provide a measure of creditor proofing or for other business reasons. Also, taxpayers often believe that it is possible to split income by transferring income producing assets to their spouses, such as shares of corporations or rental properties, and having their spouses report the income generated by those properties. This article will examine several of the provisions contained in the Income Tax Act (the Act) that prevent these simple forms of income splitting and are often overlooked by taxpayers. All statutory references are to the Act.

"Spouse"

Under the Act, common law partners (including same sex partners) are given the same status as legally married spouses. A common law partner generally is a person who cohabits in a conjugal relationship with the taxpayer and has done so for a continuous one-year period. Individuals will not be considered to be cohabiting in a conjugal relationship where they have not been cohabiting for at least 90 days because of a breakdown of their conjugal relationship. For sake of brevity, the term "spouse" in this article also refers to common law partners.

Income or Losses from Property

Under subsection 74.1 (1) of the Act, any income or loss from transferred or loaned property is attributed to and included in the transferor spouse's income for the year. This subsection severely restricts the ability of a taxpayer to split income by transferring or lending property to his or her spouse.

Suppose Mrs X has significantly higher income than Mr X and as a result pays income tax at a higher rate. Suppose also that Mrs X owns a rental property and earns income from this property. While Mrs X may consider transferring the rental property to Mr X so that Mr X will pay income tax on the rental income, subsection 74.1(1) prevents this type of plan by attributing the rental income back to Mrs X.

Subsection 74.1 (1) applies when an individual has transferred or loaned property "either directly to a spouse or indirectly by way of a trust or any other means," and can even apply when the property is transferred prior to the recipient becoming the transferor's spouse. It is important to note that subsection 74.1(1) applies to property income (i.e., interest, dividends and rents) and not business...