Introduction: Derivative Tax Liability and Transfers to a Bare Trustee
Under section 160 of Canada's Income Tax Act, one who receives property from a tax debtor may inherit derivative tax liability that is, the tax liability of the transferor.
Section 160 captures a transfer to a trustee. Yet tax jurisprudence remains unclear about whether and how the rule might apply when the transferee receives the impugned property as the trustee of a bare trust.
Generally, tax law ignores a bare trust: the beneficiary is treated as dealing directly with the trust property. This is because a bare trust is essentially, but not legally, an agency relationship where the agent holds legal title to the principal's property at the principal's sole discretion.
The nature of a bare trust suggests that section 160 shouldn't apply when a tax debtor transfers property to a bare trustee. First, advancing the analogy between agency and bare trusts, one might argue that the tax debtor's property doesn't vest in a bare trustee and thus a transfer hasn't taken place. Second, even if the creation of a bare trust constitutes a transfer, the bare trustee receives a property of seemingly nominal value that is, legal title without any of the other rights that come with true ownership.
Unfortunately, tax cases don't shed much light on either position. The jurisprudence on an agent's liability under section 160 is confused. And the Federal Court of Appeal passed on the opportunity to analyze the value of the property that a bare trustee receives under a bare trust.
This article first discusses derivative tax liability under section 160 of the Income Tax Act and the concept of a bare trust. Afterwards, it examines where the tax jurisprudence stands on the two arguments against liability under section 160 for bare trustees. Finally, the article offers some tax tips.
Section 160 of Canada's Income Tax Act
Section 160 of Canada's Income Tax Act is a tax collection tool. It aims to thwart taxpayers who try to keep assets away from Canada Revenue Agency tax collectors by transferring those assets to friends or relatives.
Section 160 is a harsh rule: It offers no due-diligence defence, it applies even if the transfer wasn't motivated by tax avoidance, and it catches transferees who don't even realize that they're receiving property from a tax debtor (e.g., see: Canada v Heavyside, 1996 CanLII 3932 (FCA), at para 3). In addition, section 160 doesn't contain a limitation period. So, the Canada Revenue Agency can assess you under the rule years after the purported transfer.
Section 160 applies if:
- A property was transferred;
- At the time of the transfer, the transferor owed a tax debt to the Canada Revenue Agency;
- The recipient was, at the time of the
- the transferor's spouse or common-law partner (or a person who has since become the transferor's spouse or common-law partner);
- a person who was under 18 years of age; or
- a person with whom the transferor was not dealing at arm's length; and
- The recipient paid the transferor less than fair market value for the transferred property.
When section 160 applies, the transferor and the recipient both become "jointly and severally" liable for the transferor's tax debt. In particular, the recipient becomes independently liable for the transferor's tax debt at the time of the transfer. This means that the Canada Revenue Agency (CRA) can now pursue both the original tax debtor and the recipient for the tax debt. In fact, even if the original tax debtor is later discharged from bankruptcy and thus released from the underlying tax debt, the recipient remains liable to the CRA (e.g.: Canada v Heavyside, ibid.)
The recipient's liability under section 160 is capped, however, at the fair market value of the transferred property. Moreover, the recipient's liability is reduced by the amount of any consideration that the recipient provided for the property. For example, a tax debtor owns a home (with no mortgage) worth $500,000 and owes $1 million to the CRA. If the tax debtor gifts the home to her son, the son's liability under section 160 is $500,000 i.e., the value of the home. If, on the other hand, the son purchased the home from the tax debtor for $250,000, the son's liability under section 160 is $250,000 i.e., the value of the home minus the purchase price.
The Trust, The Bare Trust, and Tax Treatment of Bare Trusts
The trust concept finds its roots in equity, a body of law developed in the English Court of Chancery and adopted by Canadian courts. Equity distinguishes legal ownership from beneficial ownership. A person legally owns a property if his or her name is on title, yet the beneficial owner is "the real owner of property even though it is in someone else's name." (Csak v Aumon,  69 DLR (4th) 567 (Ont. HCJ), at p. 570.)
A trust is a relationship between a trustee, a beneficiary, and a property. And it depends on the distinction between beneficial and legal ownership: the trustee legally owns the property; the beneficiary (unsurprisingly) beneficially owns the property.
Typically, the trust's creator (a.k.a. the settlor) will burden the trustee with duties to maintain or manage the trust property in the beneficiary's favour. For instance, the settlor might require that the trustee manage a large sum of money for a child or disabled beneficiary.
A bare trust, however, is a trust where the trustee legally owns a property with the sole duty of conveying title to the beneficiary upon demand. In other words, the difference between a bare trust and an ordinary trust lies in the trustee's power or discretion:
The distinguishing characteristic of the bare trust is that the trustee has no independent powers, discretions or responsibilities. His only responsibility is to carry out the instructions of his principals the beneficiaries. If he does not have to accept instructions, if he has any significant independent powers or responsibilities, he is not a bare trustee. (Trident Holdings Ltd. v Danand Investments Ltd., 64 OR (2nd) 65 (Ont. CA)).
Canada's tax laws generally look through a bare trust. Canadian tax courts treat a bare trust as akin to an agency relationship. In an agency relationship, the agent deals with property on its principal's behalf. Canada's tax laws ignore the agent and treat the principal as having dealt directly with the property. In the same way, Canada's tax laws ignore the bare trustee and treat the beneficiary as having dealt directly with the trust property.
The analogy between the bare trust and the principal-agency relationship seemingly justifies their similar tax treatment. In De Mond Jr. v The Queen,  4 CTC 2007, Justice Lamarre (as she was then) explained that "[t]he existence of a bare trust will be disregarded for income tax purposes where the bare trustee holds property as a mere agent for the beneficial owner."
Does Section 160 Apply to a Bare Trustee? The Analogy with Agency
The language of section 160 contemplates a broad range of transactions: it covers situations where a tax debtor "transferred property, either directly or indirectly, by means of a trust or by any other means whatever." Yet some jurisprudence surrounding section 160 suggests that a "transfer" hasn't taken place and the rule therefore doesn't apply when a person receives property as an agent.
One might take the similarity between agency and bare trusts to mean that section 160 also doesn't apply when a person takes legal title of a property as a bare trustee. For instance, in LeBlanc v The Queen, 99 DTC 410, a taxpayer's failing health caused his wife to take over his financial affairs. To this end, the wife deposited the taxpayer's RRSP holdings into their joint bank account, and she used the funds solely for her husband's affairs. The CRA assessed the wife under section 160 because her husband had a tax debt when she transferred his RRSP into their joint account. The Tax Court of Canada nevertheless held that no transfer took place despite the broad language of section 160. In particular, the court decided that the wife dealt with her husband's funds in the capacity of her husband's agent. As a result, the funds did not vest in the wife, no transfer took place, and section 160 therefore didn't apply. One might argue that, given the similarity between agency and bare trusts, the LeBlanc decision should extend to bare trusts. After all, when the wife transferred her husband's RRSP into their joint account, she obtained legal title over those proceeds by virtue of being the account holder. Further, she obtained legal title over those funds to use them for her husband's sole benefit. In other words, the features of the relationship between the wife, the husband, and the husband's RRSP funds match the features of a relationship between a bare trustee, a beneficiary, and the trust property. So, LeBlanc indicates that section 160 doesn't apply to a trustee who receives property upon the creation of a bare trust.
But two subsequent Federal Court of Appeal decisions complicate this line of reasoning.
In The Queen v Livingston, 2008 FCA 89, the Federal Court of Appeal cast doubt on the future weight of the LeBlanc decision. In Livingston, the tax debtor deposited funds into a friend's bank account. Although the bank account was under the friend's name, only the tax debtor used the account. All the funds in the account came from the tax debtor, the friend provided the tax debtor with the account's sole debit card, and the friend signed blank cheques for the tax debtor's use. The Canada Revenue Agency assessed the friend under section 160. When her case reached the Federal Court of Appeal, the friend argued that the LeBlanc decision meant that section 160 didn't apply. The appellate court squashed this argument by questioning the cogency of the LeBlanc decision:
The respondent cites the Tax Court of Canada's decision in Leblanc v. The Queen... . In that case, Tax Court Justice Hamlyn found that following a deposit into a jointly held bank account the property did not vest in or pass to the wife as the wife was acting as agent for her ill husband. That finding in and of itself is suspect: there was certainly a transfer of property [Livingston, ibid, at para 23].
The Federal Court of Appeal concluded that section 160 applied. The tax debtor's deposits into the friend's bank account constituted a transfer to the friend because the bank account was solely under the friend's name and thus "permitted [the friend] to withdraw those funds herself anytime." This reasoning should extend to cases such as LeBlanc involving deposits into joint accounts since a joint bank account permits either of the joint holders to withdraw all funds at anytime.
The Livingston decision suggested that one who acquired property solely as an agent wasn't thereby immune from section 160. Confusion soon followed, however.
In Lemire v The Queen, 2013 FCA 242, the Federal Court of Appeal seemingly walked back its negative take on the Tax Court's LeBlanc decision. In particular, despite its comments in Livingston, in Lemire, the Federal Court of Appeal affirmed a Tax Court decision, which ousted section 160 for essentially the same reasons that the Tax Court offered in LeBlanc.
To read more about the tax jurisprudence surrounding an agent's liability under section 160, read our tax law firm's article entitled "Do Transfers To Agents Invoke Vicarious Tax Liability Under Section 160?"
The Federal Court of Appeal has yet to clarify the extent of an agent's liability under section 160 of Canada's Income Tax Act. As a result, it's currently unclear how much sway the analogy between a bare trustee and an agent will carry in response to an assessment under section 160.
The Value of a Bare Trustee's Interest: A Missed Opportunity
One might contend that, even if section 160 applies to a bare trustee, the resulting liability should be nominal. A taxpayer's liability under section 160 is capped at the fair market value of the transferred property. Legal title is arguably of nominal value if it doesn't come with the other rights that normally accompany true ownership e.g., the right of disposition, the right of possession, the right of use and control, the right of enjoyment, the right of exclusion, etc. Yet this vapid legal title is precisely what a trustee acquires upon the creation of a bare trust. So, because the trustee acquires a property of apparently nominal value i.e., legal title without any substantive ownership rights and the section 160 liability cannot exceed that amount, the trustee seemingly bears minimal liability as a result of an assessment under section 160.
Unfortunately, this argument hasn't found much play in the tax jurisprudence. This may be because either the taxpayer's counsel or the court didn't appreciate what property was in fact being transferred.
For instance, in Livingston, the Federal Court of Appeal decided that section 160 rendered an account holder liable for a tax debtor's deposits into that account. The Federal Court of Appeal proceeded as though the tax debtor had transferred the funds themselves, but the property that was in fact transferred was legal title to the bank account. The Livingston court recognized that, in the trust context, the property transferred to the trustee is legal title to some underlying property:
Thus, subsection 160(1) categorizes a transfer to a trust as a transfer of property. Certainly, even where the transferor is the beneficiary under the trust, nevertheless, legal title has been transferred to the trustee. Obviously, this constitutes a transfer of property for the purposes of subsection 160(1) which, after all, is designed, inter alia, to prevent the transferor from hiding his or her assets. [Livingston, ibid. at para 22].
Yet it failed to see or counsel failed to point out the implication of this finding: the trustee's liability under section 160 is therefore limited to the worth of the legal title in light of the restrictions on the trustee's discretion. In other words, the value of the trustee's power over the trust property not the value of the trust property itself should determine the extent of any liability under section 160.
This trustee-liability issue currently lacks an authoritative ruling.
Tax Tips – Responding to Assessments Under Section 160
If you transfer property to your friends and relatives in an attempt to keep assets away from CRA, you expose them to CRA collections.
Similarly, consult one of our expert Canadian tax lawyers for advice on reducing your exposure to an assessment under section 160 if you plan on entering a transaction with a related party with tax debt.
If you receive a notice of assessment under section 160, you may challenge both the merits of the 160 assessment itself and the underlying tax debt. Moreover, you may challenge the underlying tax debt even if the original tax debtor failed to challenge the tax debt or challenged the tax debt yet failed to lower the amount.
But you only have a limited amount of time to object to the section 160 assessment. If you don't exercise your appeal rights in time, you're personally stuck with this liability even if the original tax debtor goes bankrupt.
The extent of a bare trustee's liability under section 160 remains unclear. The jurisprudence is still evolving. So, if you're assessed under section 160 because you obtained property or funds, and you believe that you might have been a bare trustee or an agent, you should consult with one of our Canadian tax lawyers, who thoroughly understand this area of law. Our experienced Canadian tax lawyers can ensure that you offer a forceful, thorough, and cogent response to the Canada Revenue Agency.