In the recent case of Scott v Queen 2020 TCC 4, the Tax Court of Canada released yet another decision regarding section 160 of the Income Tax Act. To put it simply, the provisions of section 160 impose liability for tax on certain transfers of property between people who do not deal at arm's length between each other. In the case of such transfers, both the transferor and the transferee are liable for certain taxes for which the transferor might have solely been liable.
The Facts of Scott v Queen
In the case of Scott v Queen, the taxpayer received three transfers in the amount of $104,000.00, $500.00 and $120,000.00 between 2005 and 2006 from his brother. The taxpayer's brother was a Canadian airline pilot who had resided in the Turks and Caicos Islands since 1993. In 2013, the brother settled a lengthy appeal with the Canada Revenue Agency ("CRA") regarding income tax on his pilot earnings. He retired from Air Canada in 2005 and wound up his RRSP, paying the Part XIII withholding taxes in 2007. As the CRA had trouble collecting the tax debt from the pilot, in 2015, the CRA issued a Notice of Assessment against his brother, the taxpayer, under section 160 of the Income Tax Act based on the aforementioned transfers between 2005 and 2006.
The taxpayer objected to the section 160 assessment on the grounds that the funds were a loan that he borrowed from his brother. Since a repayable loan isn't "transferred property" under subsection 160(1), the CRA would not be able to pursue the amounts owed. According to the brothers, they had felt no need to document the loan due to their personal relationship. However, the judge presiding over the case found multiple discrepancies in their testimony. For example, the brother testified that there was no fixed term for repayment and that he would not have sued the taxpayer to secure repayment of the borrowed money. The latter fact threw into question whether the funds were truly a loan since one important hallmark of a loan is the obligation to repay either on a fixed-term basis or on demand. On the other hand, the taxpayer testified that he had believed that the loan was repayable on demand.
Additionally, the taxpayer also testified that the purpose of the alleged transfer was to pay off the balance of the purchase price of a newly constructed condo that was not already covered. However, upon cross-examination, the taxpayer admitted that he had used his own savings to pay for the balance. Even if the previous testimony had held, this would still only cover $24,000 of the $224,500.00 that had been borrowed. Because of this lack of evidence and the inconsistent testimony, the judge declined to accept the taxpayer's explanation and upheld the CRA's categorization of the funds as a section 160 transfer.
A Brief Comparative Analysis Using Merchant v Queen
For what it's worth, the taxpayer's argument was sound. In the past, the court has recognized informal loan agreements against section 160 assessments. For example, in the case of Merchant v Queen, 2005 DTC 377, the taxpayer's father paid off the taxpayer's debts while still owing taxes and the CRA pursued the taxpayer for his father's tax debt under subsection 160(1) of the Act. On appeal, the taxpayer claimed that the amounts provided by his father were loans. Even though there was no formal agreement documenting the loan, the court allowed the appeal because the actions of the taxpayer and his father indicated a debtor-creditor relationship. There were also some handwritten notes by each party showing an intention to repay the debt.
The biggest difference between these two cases seems to come down to evidence. The presiding judge in the case of Scott v Queen was clearly unconvinced by the inconsistent testimonies of the two brothers and the taxpayer's inability to account for the funds transferred. In judge's own words; "The conclusion that I arrive at is that the parties have chosen not to divulge the true purpose of their arrangement either because it is not helpful to the Appellant's appeal or because it may jeopardize the Appellant's tax filing positions with respect to the purchase and sale of the condo or some other transaction."
Tax Tip: Don't be afraid to seek legal help from a professional
Documentation for the sake of evidence is always going to be important in any sort of legal appeal. But it's not always practical to create formal legal arrangements every time someone transfers or loans money to a family or loved one.
When you get that initial letter from the CRA in the mail, contact an experienced Toronto tax lawyer. There is a process by which defences can be raised and assumptions rebutted prior to assessments even being issued. Even after final assessments are issued, there is still a formal objection process that typically ends up reducing or outright demolishing the assessments all together and this can be done without you ever having to step into a courtroom.