The 'Excluded Shares' Exception to TOSI, Explained

Of all the exceptions to the tax on split income (TOSI) rules, "excluded shares" is often the most durable one for a family member who owns real equity in a business but doesn't necessarily work in it day-to-day. Where it applies, dividends paid on those shares can be received without TOSI turning them into top-rate income — but the test to get there has several parts, and missing any one of them means the exception doesn't apply at all.

This guide walks through what the excluded shares test looks at and where family businesses commonly get it wrong.

What the Exception Is Trying to Identify

The excluded shares exception is built around a simple idea: someone who owns a genuine, meaningful equity stake in an active business — not just a token number of shares handed out to spread income around — is behaving like a real investor, and a real investor's dividend income shouldn't be penalized the way TOSI penalizes artificial income splitting.

To qualify, the shares generally need to satisfy conditions covering three separate things at once: the size of the ownership stake, the nature of the business the corporation actually carries on, and the type of corporation itself.

The Three Things the Test Looks At

1. A Meaningful Ownership Stake

The shareholder needs to hold a genuine, direct ownership interest in the corporation — measured by both voting rights and the value the shares represent — rather than a nominal or token holding. Exactly how large a stake is required is a specific, defined threshold under the rules, and it is worth confirming the current requirement with an accountant or tax lawyer rather than assuming a family member's existing shareholding clears the bar.

2. Where the Corporation's Income Actually Comes From

The corporation generally needs to earn the bulk of its income from an active business — not predominantly from providing services. A business that is substantially a services operation faces a harder path to the excluded shares exception than one that sells products, manufactures, or otherwise runs an active operating business beyond personal services.

3. The Type of Corporation

Certain kinds of corporations, including professional corporations, are excluded from the excluded shares test entirely regardless of how the ownership and income conditions otherwise shake out. A doctor's, lawyer's, or accountant's professional corporation, for example, cannot rely on this exception even if a family member holds substantial shares in it.

A Simple Way to Think About It

All three generally need to be satisfied together — failing even one takes the shares outside the exception, though the family member's payment might still be defensible under a different TOSI exclusion, such as reasonable return.

Common Mistakes

• Assuming any share ownership is enough. A small or symbolic shareholding issued mainly to justify a dividend is unlikely to meet the ownership threshold the test actually requires.
• Not checking the corporation's income mix. A business that looks like it sells products but actually derives most of its revenue from personal services may not qualify, even with substantial share ownership.
• Overlooking professional corporation status. Family members holding shares in a professional corporation sometimes assume the same planning available to other corporations applies to them — it doesn't, for this particular exception.
• Treating the test as a one-time check. A corporation's income mix or share structure can shift over time, and a corporation that qualified in one year isn't guaranteed to qualify in the next.

Frequently asked questions