Introduction: Derivative Tax Liability & Life-Insurance Beneficiaries
Section 160 of the Income Tax Act broadens the Canada Revenue Agency's power to collect on income-tax debt. Under section 160 of Canada's Income Tax Act, if you receive property from a tax debtor, you may inherit derivative tax liability—that is, you could get stuck with the tax debtor's income-tax bill. And the Canada Revenue Agency (CRA) can now pursue you with its full gamut of tax-collection powers—e.g., withholding income-tax refunds and GST/HST credits, garnishment, debt registration, lien, asset seizure, etc.
Moreover, this rule doesn't depend on the tax debtor's desire to avoid paying income tax; it applies even if the tax debtor gave you the property without any intention of depriving or dodging CRA income-tax collectors. And it applies even if you didn't know that the person from whom you received the property owed income tax.
By extension, this means that you could unwittingly expose your loved ones to your tax debt by transferring property to them while you owe income tax.
Many Canadians rely on life insurance to ensure that their loved ones remain financially secure. If your family relies on your income or if you carry significant debt, your life-insurance payout can serve to support your spouse or child, or to maintain the assets in your estate, should you pass away unexpectedly.
But if you pass away with income-tax debt, are your life-insurance beneficiaries now exposed to that liability under section 160 as a result of receiving the insurance proceeds?
This article examines whether section 160 of the Income Tax Act allows the CRA to chase your life-insurance beneficiaries for your income-tax debt. First, we examine the provisions of section 160 in more detail. After that, we consider three arguments that section 160 doesn't apply to a beneficiary who receives proceeds from a tax debtor's life-insurance policy: (i) the life-insurance payout isn't a transfer from the tax debtor; (ii) tax jurisprudence suggests that section 160 doesn't apply to a life-insurance beneficiary; and (iii) the application of section 160 to a life-insurance beneficiary seemingly doesn't square with the purpose underlying the tax-collection rule. Finally, we offer some tax tips relating to avoiding third-party tax liability under section 160.
Section 160 of Canada's Income Tax Act
Section 160 aims to prevent a taxpayer from avoiding tax liability by transferring property to a non-arm's-length person—thereby depriving the CRA of access to the asset while still possibly benefitting from it (Campbell v The Queen, 2009 TCC 431, at para 16).
The rule applies if "a person has [...] transferred property, either directly or indirectly, by means of a trust or by any other means whatever, to
- the person's spouse or common-law partner or a person who has since become the person's spouse or common-law partner,
- a person who was under 18 years of age, or
- a person with whom the person was not dealing at arm's length [...]."
The language of section 160 contemplates a broad range of transactions involving a party related to the tax debtor. It catches each of the following transactions:
- a direct transfer to a related party—e.g., an outright gift to a spouse or child, a dividend from a corporation to a shareholder;
- an indirect transfer to a related party—e.g., a transfer to an arm's-length party who in turn transfers the property to a spouse or child;
- a transfer to a trust for the benefit of a related party—e.g., a transfer of property to an inter vivos or testamentary spousal trust, an estate's distribution of property to the deceased's widow or child; and
- a transfer to a related party "by any other means whatever"—in other words, a statutory catch-all for good measure.
If section 160 does apply, the transferor and the recipient both become "jointly and severally" liable for the transferor's income-tax debt. So, while the transferor remains liable for the tax debt, the recipient now becomes independently liable for the transferor's tax debt as of the date of the transfer.
This means that the Canada Revenue Agency can now pursue each—the original tax debtor and the recipient—for the same income-tax debt.
The recipient's tax 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: suppose that the tax debtor owns a home (with no mortgage) worth $1 million and owes $2 million to the Canada Revenue Agency. If the tax debtor gifts the home to her son, the son's liability under section 160 is $1 million—that is, the value of the home. If, on the other hand, the son purchased the home from the tax debtor for $500,000, the son's liability under section 160 is $500,000—that is, the value of the home minus the purchase price.
Subsection 160(3) speaks to discharging the derivative tax liability. If the new tax debtor—i.e., the one who inherited someone else's income-tax debt—pays off the derivative liability, it will discharge that tax debt for both the original tax debtor and the tax debtor under section 160. But the original tax debtor's payments will discharge the new debtor's liability only if the original debtor has first paid off all income-tax debt that doesn't relate to the amount assessed to the new debtor.
Continue from the example above: the original tax debtor owes $2 million to the Canada Revenue Agency, and her son has inherited $500,000 of her tax debt under section 160. If the son pays off his $500,000 derivative tax debt, then he'll completely discharge his own tax liability, and he'll reduce his mother's tax liability from $2 million to $1.5 million. If the mother pays $500,000 towards her own tax debt, she'll reduce her own tax liability from $2 million to $1.5 million. But her son's derivative tax liability won't budge. Mom won't be able to offset any of her son's derivative tax liability until she first pays off $1.5 million of her own tax debt. Only then will her payments toward her remaining $500,000 tax debt discharge her son's derivative liability dollar for dollar.
Canadian courts readily admit that 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. 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 (Canada v Heavyside, ibid.).
Further, the liability under section 160 is transitive: after inheriting another's tax liability under section 160, you can spread the misery should you subsequently transfer any property to a yet another party with whom you don't deal at arm's length. The CRA may now pursue that person under section 160 for your own section-160 liability.
Are Life-Insurance Beneficiaries Subject to Derivative Tax Liability Under Section 160?
We offer three arguments that section 160 doesn't apply to a beneficiary who receives proceeds from a tax debtor's life-insurance policy. First, a life-insurance payout isn't a "transfer" from the tax debtor. Second, Tax Court jurisprudence—while not expressly deciding the issue—strongly suggests that section 160 doesn't apply to a life-insurance beneficiary. Finally, the application of section 160 to a life-insurance beneficiary wouldn't further the rule's purpose.
To focus the analysis, we assume that the life-insurance policy's owner is the person whose life is insured, and that the life-insurance beneficiary is a party related to the policy owner. In other words, the relationship between the policy owner and the life-insurance beneficiary is such that, but for the points below, section 160 would otherwise apply.
The Owner of a Life-Insurance Policy Doesn't Transfer Property to the Policy Beneficiary
By taking out a life-insurance policy, the policy owner doesn't thereby transfer property to the life-insurance beneficiary.
A transfer of property requires that the transferor divest himself of the property and that the property vest in the transferee (Fasken Estate v Minister of National Revenue,  Ex. CR 580, at para 12). This entails that "the transferee's patrimony actually receive the property in question, and that the transfer result in an enrichment. If the effect of the alleged transfer is neutral, the transferee will not be liable to the tax authorities [as a result of subsection 160(1)] (Lemire v the Queen, 2012 TCC 367, at para 36).
In other words, subsection 160(1) applies when the control, possession, use, and benefit of the property vests in the transferee. For instance, in both Woodland v the Queen and Wannan v Canada, a tax debtor's contribution of assets into a spouse's RRSP constituted a transfer to the spouse because, once in the RRSP, the assets were solely under the spouse's control and possession, and the spouse would benefit exclusively from any increase in the assets' value. Likewise, in the Queen v Livingston, the tax debtor deposited funds into a friend's bank account. The Federal Court of Appeal held that the deposit 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. The property transferred was the right to require the bank to release all the funds to the respondent." And again, in Gitelman v the Queen, the court concluded that subsection 160(1) applied where a tax debtor paid $10,000 to her son for his wedding expenses. The payment constituted a transfer to the son because the son personally benefitted from reduced wedding expenses.
A policy owner's life-insurance policy fails to comprise a "transfer" to the beneficiary. First, while the policy owner is divested of the funds that paid toward the premiums, these funds vest in the insurance company—a party with whom the policy owner normally deals at arm's length. Further, under most insurance contracts, the premium payments are non-refundable if the policy owner cancels the insurance policy or the insurance company voids the insurance contract. In addition, the policy owner's total premium payments to the insurance company may exceed or undershoot the amount of the death benefit. As a result, the amount of premiums ultimately paid by the policy owner is unrelated to the amount that the beneficiary shall receive upon the policy owner's death. In other words, it seems unlikely that the policy owner's premium payments could be construed as an indirect transfer to the beneficiary by way of funding the insurance proceeds.
In addition, the insurance proceeds don't vest in the beneficiary until the policy owner's death. Yet the transferor of those funds is not the policy owner but the insurance company. So, while the insurance payment to the beneficiary will indeed be a transfer of property, it won't be a transfer from the policy owner. That is, the insurance company will pay those funds directly to the plan's beneficiary.
Granted, one might rebut by drawing an analogy to the seemingly negative case law involving RRSP beneficiaries. In Kuchta v The Queen, for instance, a taxpayer was the beneficiary of her husband's RRSP. Upon her husband's death, the taxpayer received over $300,000 from his RRSP by virtue of her beneficiary designation. The Minister of National Revenue assessed the taxpayer under section 160 on the basis of her husband's income-tax debt. The taxpayer appealed the assessment. In dismissing the taxpayer's appeal, the court held that section 160 applied to the taxpayer's receipt of the proceeds from her late husband's RRSP.
But this result proves irrelevant in the context of a life-insurance payout. Unlike deposits into an RRSP, payments of life-insurance premiums are consideration for services rendered—that is, consideration under the terms of the insurance contract whereby the owner agrees to pay the premiums and the insurer promises to pay the death benefit to a beneficiary. Indeed, this is why the insurance premiums are non-refundable (beyond a statutory rescission period). Moreover, the premium payments need not coincide with the amount of the death benefit. By contrast, an RRSP is simply a tax-preferred savings or investment account. The RRSP holder contributes his own funds to the account for his own later use and benefit. The deposits are not consideration to a third party; they are the RRSP holder's own property. So, while the beneficiary of a deceased's RRSP inherits the deceased's property and thereby receives a transfer from the deceased, the beneficiary of life-insurance proceeds receives property that the deceased never owned. For that reason, cases like Kuchta should not apply in the context of a life-insurance payment to a policy beneficiary.
In summary, by taking out a life-insurance policy, the policy owner does not thereby transfer property to the beneficiary under that policy. His premium payments are transfers to a third party—in particular, the insurance company. Moreover, while the payment of the death benefit is a transfer to the beneficiary, it is not a transfer from the policy owner. Also, the application of section 160 to a beneficiary of an RRSP shouldn't extend to the beneficiary of a life-insurance policy. Unlike the beneficiary of an RRSP, the beneficiary of a life-insurance policy doesn't receive a property in which the policy owner would have had an ownership interest.
Tax Jurisprudence Presupposes that Section 160 Doesn't Apply to a Life-Insurance Beneficiary
Tax Court jurisprudence supports the contention that section 160 does not apply to a payout of life-insurance proceeds. In particular, while not expressly holding that section 160 does not apply to the beneficiary of a life-insurance death benefit, the court has presupposed this principle in at least two decisions.
First, in Nguyen v Canada, a taxpayer received proceeds as the beneficiary of her deceased husband's life insurance. The taxpayer directed her daughter to open a bank account through which the taxpayer intended to deposit and invest the life-insurance proceeds. Although the taxpayer intended to use the bank account solely for her personal investments, her daughter mistakenly opened the account under the name of the deceased's estate. Failing to notice the incorrect name on the bank account, the taxpayer proceeded to use the life-insurance funds to finance her investments. The CRA assessed the taxpayer under section 160. Her husband's estate had income-tax debt. And the CRA alleged that, because the taxpayer personally used funds from a bank account in the name of the estate, she had received a transfer from the estate and provided no consideration. The Tax Court held that section 160 did not apply. It found that the bank account was only mistakenly opened in the name of the estate. The money within the account was in fact solely that of the taxpayer. In rendering its decision, the court did not expressly hold that section 160 cannot apply to a life-insurance beneficiary. Yet the court's reasons suggest that, if the life-insurance proceeds had been paid into a bank account correctly naming the taxpayer as its owner, section 160 would unquestionably fail to apply:
- We must first and foremost, in my opinion, determine whether, after the death of the insured, the proceeds of the insurance policies held by the late Hien Vohoang, who had not designated his "estate" as beneficiary, became part of the assets of his estate, so that the Minister was warranted in making the assessments in issue. In other words, the issue is whether the mere fact that a bank account was opened in the name of the estate and money was deposited to it make that money an asset of the estate. [...]
- It is therefore clear that succession is simply a word that includes the transfer of rights and obligations of a deceased to his or her family members, and that the devolution takes place either by operation of law (succession ab intestat) or by will. Unless it is stipulated that the deceased's life insurance is payable "to my estate", the proceeds are not part of the estate and do not comprise a right that is part of the patrimony of the deceased, in this case the late Hien Vohoang.
In Higgins v The Queen, the Tax Court more strongly hinted that section 160 cannot apply to a life-insurance beneficiary. In Higgins, a taxpayer received death-benefit proceeds as the beneficiary of her deceased father's London Life plan, which had features of both a life-insurance policy and an investment fund. The CRA assessed a taxpayer under section 160 on the basis that she received funds from a plan belonging in the same category as an RRSP. The court disagreed. It found that the plan's "overarching feature was the life insurance component." It went on to reason that the Nguyen decision applied even more so on these facts—that is, unlike the taxpayer in Nguyen, the taxpayer in Higgins had no need to contend with a mislabeled bank account, nor did she administer her father's estate:
- I find the decision in Nguyen is applicable to the within appeals. The amount paid to each appellant from that segregated fund constituted life insurance proceeds which were payable to each of them as a designated beneficiary and did not form assets of the Estate of the late Arthur W. Higgins. Unlike the circumstances in Nguyen, there were no indicia of any connection between the funds from that plan and the Estate of the late Arthur W. Higgins which had no assets, was not administered and, in relation to which, Kinnis specifically disavowed any legal status when dealing with various representatives of CRA.
Although the Nguyen court focused on whether funds belonged to an estate by virtue of the fact that they sat in a bank account in the estate's name, the court's reasoning presupposed that section 160 does not apply to one who receives life-insurance proceeds from an insurer. The Higgins decision comes even closer to announcing that section 160 fails to apply to a life-insurance beneficiary.
The Application of Section 160 to the Receipt of Life-Insurance Proceeds Doesn't Advance the Rule's Purpose
Finally, the application of section 160 to a beneficiary of a life-insurance policy goes against the purpose underlying the rule.
Section 160 aims to "preserve the value of the existing assets in the taxpayer for collection by the CRA" (Canada v. Livingston, 2008 FCA 89, at para 27). And it "prevents taxpayers from escaping their liability for tax, interest and penalties arising under the provisions of the Act by placing their exigible assets in the hands of relatives, or others with whom they are not at arms' length, and thus beyond the immediate reach of the tax collector" (Logiudice v. Canada,  TCJ No 742 (QL), 97 DTC 1462, at para 16).
This suggests that section 160 should not capture a beneficiary who has received a death-benefit under a life-insurance policy. In particular, the insurance proceeds that would be payable to the life-insurance beneficiary don't come from—and thus don't undermine the value of—the policy owner's assets. As a result, the Canada Revenue Agency isn't prejudiced by the beneficiary designation: it probably couldn't ever have collected from the policy owner's assets an amount equal to that of the death benefit.
The CRA is also not prejudiced by the policy owner's payment of premiums. First, these funds go to an insurance company, which is typically a party with whom the policy owner deals at arm's length. This, in contrast to a transfer to a related party, makes it unlikely that the policy owner has artificially divested himself of assets to move them beyond the CRA's reach. Second, in exchange for these premiums, the insurance company has promised to pay a designated beneficiary an amount that presumably would otherwise come from the policy owner's estate. In other words, like section 160 itself, life insurance in principle serves to "preserve the value of the existing assets in the taxpayer for collection by the CRA".
Tax Tips – Avoiding Third-Party Income Tax Liability under Section 160
While the analysis in this article suggests that section 160 doesn't apply to a payout of life-insurance proceeds directly to the insurance beneficiary, the rule likely applies if those proceeds flow through the tax debtor's estate. The Nguyen and Higgens cases illustrate that, if a tax debtor designates his or her estate as the beneficiary of the life insurance and the estate pays the life-insurance proceeds to the deceased tax debtor's friends and relatives, the estate beneficiaries are vulnerable to tax liability under section 160. This is because a deceased tax debtor's estate will assume the deceased's income-tax debt, and, under the Income Tax Act, an estate and its beneficiaries don't deal at arm's length. So, if the life-insurance proceeds flow through the tax debtor's estate while the estate carries income-tax debt, a distribution will constitute a transfer to the estate's beneficiaries that is subject to section 160.
The same is true for the beneficiary of a deceased tax debtor's RRSP. For, as the Kuchta case illustrates, an RRSP is simply a tax-preferred savings or investment account. As an RRSP holder, you contribute your own funds to the account for your own later use and benefit. Unlike life-insurance premiums, deposits into an RRSP aren't consideration to a third party; they consist of your own money or investments. So, when you pass away, the designated beneficiary of your RRSP inherits your property and thereby receives a transfer—"indirectly or by any means whatever"—from you. So, if you have unpaid income-tax debt, the beneficiary of your RRSP is vulnerable to a third-party income tax assessment under section 160.
Consult one of our expert Canadian tax lawyers for advice on reducing your exposure to a tax assessment under section 160 if you believe that you may inherit or receive property from someone with income-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 of the transferor. Moreover, you may challenge the underlying tax debt even if the original tax debtor failed to challenge the tax debt, or he or she 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.
So, if you're assessed under section 160 because you obtained property or funds, speak with one of our experienced Canadian tax lawyers. We have a thorough understanding of this area of law, and we can ensure that your response to the Canada Revenue Agency is forceful, thorough, and cogent.