TRANSFERRING DIVIDENDS BETWEEN SPOUSES

This newsletter addresses an often-overlooked area in tax planning—the ability to transfer dividend income between spouses under subsection 82(3) of the Income Tax Act (the “Act”)—including a dimension involving the Tax on Split Income (“TOSI”) rules that is rarely discussed. This can produce meaningful results when applied correctly.

TRANSFERRING DIVIDENDS BETWEEN SPOUSES

Many practitioners are unaware of this provision, and the mechanics of the subsection 82(3) election and its interaction with the TOSI rules are often underutilized.

(a) The Basic Election

Where the lower-income spouse (referred to here as Spouse A) has received Canadian dividends but has little taxable income, the associated dividend tax credit may go entirely or partially unused. Subsection 82(3) of the Act permits an election to include all of Spouse A’s dividends from taxable Canadian corporations in the income of the higher-income spouse (Spouse B). Doing so can create or increase the spousal tax credit available to Spouse B by reducing Spouse A’s reported income.

This strategy is most effective where:

• Spouse A has little or no taxable income, rendering the dividend tax credit ineffective in Spouse A’s hands;
  

• Spouse B is eligible for the spousal credit, which is reduced dollar-for-dollar as Spouse A’s net income rises; and
  

• the numbers, when run through tax software, confirm a net saving for the couple.

  
  

  

Important mechanics: the election is all-or-nothing — all of Spouse A’s dividends from taxable Canadian corporations must be transferred; partial elections are not permitted. The election is available only if it creates or increases the spousal credit for Spouse B. Running the numbers in both directions before filing is essential, as the election does not always produce a saving.

(b) The TOSI Dimension — A Less-Known Planning Opportunity

Since 2018, the TOSI rules under Section 120.4 of the Act have required that dividends paid by a family business to certain family members be taxed at the top marginal rate, unless an exemption applies. One key exemption is the “excluded share” rule - if the dividend recipient is 25 or older and personally holds shares representing at least 10% of the votes and value of a non-professional, non-service corporation, those dividends are excluded from TOSI and taxed at normal graduated rates.

The planning opportunity arises where Spouse A holds shares in the family company that do not qualify as excluded shares — for example, because the corporation derives primarily service income, or because Spouse A holds less than 10% of votes and value — so that dividends paid to Spouse A would ordinarily be subject to TOSI. If Spouse B’s shares in the same corporation independently qualify as excluded shares, the subsection 82(3) election will recharacterize those dividends entirely.

The CRA’s confirmed position, set out in Internal Technical Interpretation 2020-0856081I7 (August 2021), is that TOSI is applied after the subsection 82(3) reallocation. When Spouse B makes the election, the dividend is deemed to have been received by Spouse B, and TOSI is then evaluated based on Spouse B’s shareholding — not Spouse A’s. Because Spouse B holds excluded shares, TOSI does not apply, and the dividend is taxed at normal rates in Spouse B’s hands. In a family where Spouse A would otherwise face a top-rate TOSI charge, this result can be significant.

Three limitations must be kept firmly in mind:

• No aggregating shareholdings. The spouses cannot combine their respective holdings to reach the 10% threshold. Each must independently satisfy the excluded share conditions. If Spouse A holds 6% and Spouse B holds 6%, neither qualifies.
  

• The election cuts both ways. If Spouse A holds excluded shares but Spouse B does not, making the election would strip Spouse A’s excluded-share protection, causing TOSI to apply based on Spouse B’s deemed receipt when it otherwise would not have. Always evaluate in both directions before filing.
  

• The spousal credit condition still applies. The subsection 82(3) election is available only if it creates or increases the spousal credit for Spouse B. That requirement must be satisfied before the TOSI benefit can be achieved.

(c) Reinvestment of Proceeds by Spouse A

A question that naturally follows: once Spouse B has reported the dividend income and paid tax on it, can Spouse A — who physically received the cash from the corporation — reinvest those funds without triggering the attribution rules or a further TOSI charge?

The answer, in most cases, is yes — subject to one important qualification. Spouse A should be careful about reinvesting the dividend proceeds back into the family corporation or a related business, as doing so can re-attract TOSI exposure.

Attribution (Section 74.1 of the Act). The attribution rules are triggered by a transfer or loan of property from one spouse to another. In this structure, no such transfer occurred. The corporation paid the dividend directly to Spouse A as the registered shareholder; the subsection 82(3) election is a tax-reporting mechanism only, not a property transaction. No cash moved from Spouse B to Spouse A. Accordingly, there is no basis for Section 74.1 to attribute investment income subsequently earned by Spouse A back to Spouse B. The CRA’s archived Interpretation Bulletin IT-295R4 confirms that the attribution rules and the subsection 82(3) election operate on separate tracks.

TOSI on reinvested proceeds. Section 120.4 contains a substituted-property rule under which income earned on assets acquired with split-income proceeds is itself treated as split income and taxed at the top marginal rate. The critical point here is that because the subsection 82(3) election (combined with Spouse B’s excluded shares) removed the original dividends from the TOSI regime entirely, they were never split income to begin with. There is no tainted-source foundation from which the substituted-property rule can operate. The concern with reinvestment is therefore not that rule — it is whether the deployment of the proceeds itself generates TOSI-exposed income in Spouse A’s hands. Where Spouse A invests the proceeds matters:

• Third-party investments (publicly traded shares, GICs, bonds, mutual funds): income from these is not income from a “related business,” and TOSI has no foothold. Spouse A is in the clear.
  

• Reinvestment into the family corporation (acquiring additional shares, or lending funds back to the corporation): because Spouse A remains a specified individual, future dividends paid on any newly acquired shares that do not meet the excluded share test will themselves be split income subject to TOSI. Similarly, interest on a shareholder loan to a related business is potentially subject to TOSI. The TOSI exposure here is on the future income generated by those investments, not on the reinvestment transaction itself.

There is, however, a planning opportunity within this scenario. If the reinvestment of proceeds into the family corporation brings Spouse A’s shareholding to at least 10% of the votes and value of a qualifying corporation — or if the corporation declares a stock dividend that achieves the same result — Spouse A’s shares would then constitute excluded shares. Future dividends paid on those shares would then be exempt from TOSI, removing the exposure going forward. In the right circumstances, what might appear to be a risk zone becomes a path to permanently sheltering Spouse A’s dividends from TOSI.

The clean version of this structure — dividends declared, the subsection 82(3) election made, Spouse A reinvesting the proceeds into an arm’s-length investment portfolio — achieves the full benefit. Spouse B is taxed on the dividend at normal graduated rates, and Spouse A builds a personal investment account with no attribution and no TOSI exposure on the returns. The cash effectively steps outside the family-business ecosystem.

Because this combination of provisions is not extensively documented in the published commentaries, where a client intends to rely on it for a material amount, a well-documented tax opinion is prudent before proceeding.

This strategy is hidden in plain sight, yet can produce meaningful results in the right fact pattern. If you have questions or wish to discuss any of these matters for a specific client, please feel free to reach out.

As always, I am happy to work with you and your advisors to ensure the best tax outcomes.

--Chuck