Below are two examples of the common use of income sprinkling in Canada under the existing tax laws.

• Currently, a Canadian family may all hold shares in a corporation where one parent works. The corporation pays the working parent a salary lower than he or she would receive elsewhere for the same services. The corporation then pays the spouse and adult children discretionary dividends to compensate for the difference in salary. The after-tax savings for the family can be substantial due to the ability to use the lower tax rates of the additional family members.
• Currently, a Canadian family may all hold shares in a corporation where one parent works either directly or through a Family Trust. When the parent retires by selling the corporation, each family member who holds shares or is a beneficiary of the trust is able to utilize their Lifetime Capital Gains Exemption (LCGE) to each receive up to $835,716 of the gain on sale of the corporation tax-free (indexed to inflation).

Currently, there are reasonability rules in place on salaries paid to family members. The proposed changes would introduce reasonability tests on dividends paid to adult family members. These reasonability tests would be based on the labour contributions, contributed assets, assumed the risk of and previous returns of the adult family member.

Dividends in excess of the government’s interpretation of reasonability would be subject to the top marginal tax rates. The tax increase to a family of four on an income of $220,000 would be approximately $35,000. The proposed tax changes would prevent individuals under the age of 18 from qualifying for the Lifetime Capital Gains Exemption (LCGE).

The reasonability tests described above would be used to determine whether the LCGE applies to the capital gain. Any gains that are accrued during the time the corporation was held by a trust would no longer be eligible for the LCGE. The tax increase would be approximately $200,000 per individual who no longer qualifies for the LCGE.