Defending a Family Dividend Structure Against a TOSI Reassessment

The situation

Miriam is a surgeon in Newmarket who runs her practice through a professional corporation. Over the years she had also built a second business: a corporation that owns and manages a handful of commercial rental units, bringing in steady income on top of her medical practice. Both corporations paid annual dividends to Miriam, her spouse Meron, and their adult daughter Selam, all of whom held shares.

Meron had spent years managing the rental portfolio directly: negotiating leases, coordinating repairs, chasing down tenants on payment, and dealing with the properties' insurance and municipal obligations. Selam, in her mid-twenties, worked part-time as the office manager for Miriam's surgical practice, handling scheduling, billing submissions, and staff coordination while finishing a graduate degree. Both were paid partly through salary and partly through dividends on the shares they held.

The family had never treated this as aggressive planning. Dividends were declared through their accountant each year, minute books were kept up to date, and both Meron and Selam genuinely worked in the businesses. But in early 2025, that arrangement came under direct challenge.

The problem

The Canada Revenue Agency opened an audit of both corporations, focused on a set of rules known as the tax on split income, or TOSI. These rules were introduced to stop business owners from routing income to family members in lower tax brackets who were not genuinely contributing to the business. Where TOSI applies, dividends that would otherwise be taxed at the recipient's own rate are instead taxed at the highest personal marginal rate, regardless of the recipient's actual income.

The CRA auditor's position was blunt: Meron and Selam's involvement did not, in the auditor's view, rise to the level the rules require, and every dividend paid to them over the prior three years should be reassessed at the top rate. Across both corporations, the dividends in question totalled roughly $1.4 million over the audit period. Reassessing that amount at the top marginal rate instead of the rates Meron and Selam had actually paid meant an additional tax bill, once penalties and arrears interest were added, of roughly $650,000 — money the family did not have sitting aside, since the dividends had long since been spent, reinvested in the rental properties, or put toward Selam's tuition.

The stakes were real on both ends. If the reassessment stood, the family would owe a sum in the high six figures on income they believed had already been taxed correctly. If it didn't, the family kept the structure they had built in good faith. Miriam retained our team to respond to the audit before it hardened into a formal reassessment she would have to appeal.

What we did

1. Mapped the family's actual work against the statutory exemptions. The tax on split income rules, found in the Income Tax Act, exempt several categories of recipients from the top-rate treatment. One exemption applies to a person who works substantially in the business — generally understood as averaging at least 20 hours a week during the relevant part of the year. Another allows a family member to keep a dividend that is a reasonable return given their labour, the capital they contributed, and the risk they carried. We assessed Meron and Selam separately against both tests, because their situations were different.
2. Reconstructed Meron's time in the rental business. Meron had never kept a formal time log — most family business owners don't, until an audit forces the question. We worked with Meron to reconstruct a defensible record from lease files, email correspondence with tenants and contractors, bank records showing direct involvement in paying suppliers, and calendar entries for property walk-throughs and inspections. Property management of this kind is hands-on, recurring work, and the reconstructed record supported hours well above the threshold for most of the year.
3. Built the reasonable-return case for Selam. Selam's part-time hours in the medical practice were real but lower, so we did not try to argue she met the same hours threshold Meron did. Instead we documented the market value of the office management work she performed, compared her dividend against what an unrelated office manager doing similar work would reasonably be paid in total compensation, and showed her dividend fell within that range once her salary was netted out. The reasonable-return exemption does not require a fixed number of hours — it asks whether the amount paid fairly reflects the contribution made.
4. Prepared a formal written response before the reassessment issued. Rather than wait for a notice of reassessment and then object, we responded directly to the auditor's proposal letter with the supporting records, a written analysis applying each exemption to each family member and each tax year, and a request to discuss the file before it was finalized. Responding at the proposal stage, before a reassessment is formally issued, keeps the matter at the audit level rather than pushing it into a separate objection and possible Tax Court process, which takes longer and costs more on both sides.
5. Followed up directly with the auditor's team lead. When the initial response did not move the file, we requested a call with the auditor and their team lead to walk through the record in person, rather than leaving it to further rounds of written correspondence. That conversation clarified which specific gaps in the paper trail the CRA still wanted addressed, and we closed those gaps with a supplementary submission within a few weeks.

The outcome

The CRA accepted that Meron's involvement in the rental business met the hours-based exemption for the years in question, and that Selam's dividends were a reasonable return on her contribution to the medical practice. The proposed reassessment was withdrawn in full. No additional tax, penalties, or interest were assessed against Miriam, Meron, or Selam on the dividends the audit had targeted.

The process took several months from the initial audit letter to written confirmation that the file was closed. Miriam described the uncertainty in the middle of it as the hardest part — not knowing for months whether the family would need to find $650,000 they didn't have sitting aside. What ultimately resolved it wasn't a clever argument; it was that the underlying facts were genuine, and the family was able to prove them with records that existed or could be reconstructed credibly.

Since then, Miriam's corporations have changed how they document family compensation going forward. Meron now keeps a simple contemporaneous log of hours on the rental properties rather than reconstructing one after the fact, and the accountant reviews each year's dividend allocations against the same exemption tests before they are declared, rather than after an audit letter arrives.

The case also prompted a broader look at how the two corporations paid Miriam herself. Her accountant had historically split her own compensation between salary and dividends based mostly on cash-flow timing rather than any documented rationale. We recommended the corporations adopt a short annual memo, prepared alongside the year-end dividend resolutions, setting out who worked how much in each business and why each dividend amount was reasonable in light of that work. It is a modest amount of paperwork compared to the cost of defending the same question years later without it.

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