Introduction – Derivative Liability for Income Tax and GST/HST
The Canada Revenue Agency (CRA) has access to an arsenal of legal tools to ensure it can collect income tax and GST/HST from taxpayers. One method that some taxpayers have used to attempt to avoid having to pay the tax they owe is to transfer their assets to their spouses, family members, or to corporations under their control. The theory behind this method is that since the taxpayers are the ones who owe the tax and not persons receiving the assets, the CRA will not be able seize the assets to satisfy the taxpayers' liability since the assets are no longer owned by the taxpayers. Unfortunately for taxpayers employing these methods, one of the Canada Revenue Agency's most powerful legal tools is designed specifically address situations like this. When the right conditions are met, the CRA has the power to assess persons who received property from taxpayers who have outstanding income tax or GST/HST owing. White v. The Queen helps show what the limits of the Canada Revenue Agency's ability to use this power are.
Derivative Liability for Income Tax and GST/HST – Sections 160 and 325
CRA's ability to assess and collect income tax and GST/HST from persons who receive property from a tax debtor comes from section 160 of the Income Tax Act and section 325 of the Excise Tax Act. The following conditions need to be met before the CRA can assess under these sections:
- A taxpayer transferred property to another person,
- At the time of the transfer, the taxpayer had unpaid income tax or GST/HST liability,
- The person receiving the transferred property is non-arm's length from the taxpayer, and
- The person receiving the property provided nothing or something of lesser value in exchange for the property received.
If these conditions are met, the person receiving the property can be assessed by the CRA for the lesser of the amount owed by the taxpayer and the value of the property the person received minus the value of whatever they provided to the taxpayer in exchange for the property (if anything). The spouse of a taxpayer is always non-arm's length from that taxpayer.
Facts – White v. The Queen
Mr. Andrew White (the "Husband") and Ms. Tammy White (the "Wife") married in 1984 and set up a joint bank account with both their names on the account and no other names on the account. The Husband and Wife used the joint account to pay their personal expenses and that of their family.
The Husband was the director of a corporation which ran into financial difficulties. As a result, he was assessed for the $49,962.45 of unremitted payroll withholdings and $90,886.35 of unremitted GST/HST of the corporation. The Husband was unable to continue his work with that corporation and found employment at a new company on March 15, 2013. He deposited his pay from his work at the new company into the joint bank account. On March 26, 2014 the Husband entered into a consumer proposal. Between March 15, 2013 and March 26, 2014 he deposited $89,806.72 of his pay into the joint account.
The Wife also had a bank account that was solely in her name. The Wife deposited her salary from her own employment into that account. The Wife owned a home that was solely in her name which had a mortgage associated with it. The Wife also had a line of credit.
Between March 13, 2013 and March 26, 2014 an aggregate amount of $34,052 was transferred from the joint account to the Wife's personal bank account, the Wife's line of credit, and the mortgage on the Wife's house. The Wife did not provide any consideration for these amounts.
On March 1, 2016 the CRA assessed the Wife for $49,962.45 under section 160 of the Income Tax Act and for $90,886.35 under section 325 of the Excise Tax Act. The Canada Revenue Agency's basis for these assessments was that the Husband deposited funds into the joint account between March 15, 2013 and October 30, 2015. The CRA's position was that these funds constituted a transfer for no consideration to a non-arm's length individual, specifically the Wife.
The Court's Analysis – White v. The Queen
The Tax Court of Canada held that the deposit of funds by the Husband into joint account did not constitute a transfer of property to the Wife. The Tax Court of Canada did however hold that the amounts transferred from the joint account to the Wife's personal bank account, line of credit, and mortgage did constitute transfers of property. As a result, the Tax Court of Canada found that the Wife's total liability was $34,052, not the $140,848.80 for which she was originally assessed. The other criteria necessary for the application of section 160 of the Income Tax Act and 325 of the Excise Tax Act were not discussed by the Tax Court of Canada and may not have been disputed by the Wife.
The Tax Court of Canada relied on two primary principles in deciding that the deposits into the joint account did not constitute a transfer of property from the Husband to the Wife. The first is that in order for there to be a transfer of property in the context of section 160 of the Income Tax Act and 325 of the Excise Tax Act, the taxpayer must deal with the property so as to divest him or herself of that property and have that property vest in the non-arm's length person. The Tax Court of Canada took the fact that the Husband could still access the amounts deposited in the joint account to mean that he had not divested himself of the property, and so concluded that depositing the funds into the joint account did not constitute a transfer
The second is that the interpretation the criteria of for applying section 160 of the Income Tax Act and 325 of the Excise Tax Act should be informed by the purpose of those sections. The Tax Court of Canada identified that purpose as preventing taxpayers from thwarting the Canada Revenue Agency's efforts to collect the tax owed by taxpayers. The Tax Court of Canada took the view that the Husband did not hinder the CRA's efforts to collect tax by depositing the funds into the joint account and pointed out that the Canada Revenue Agency could have garnished the joint account to collect the tax owing
The Tax Court of Canada's decision for this case did not discuss in detail why the transfer of amounts from the joint account to the Wife's personal account, mortgage, and line of credits did constitute a transfer of property to the Wife, but did reference a previous case in which a transfer to the bank account of a different person was considered to be a transfer of property. However, the decision to treat the transfers to the Wife's personal account, mortgage, and line of credits is explicable in terms of the principles used to analyze the deposits into the joint account. Once the amounts were removed from the joint account, the Husband no longer had a right to demand access to those funds from a financial institution and no other circumstances that would give the husband another type of legal right to access the funds were discussed in the Tax Court of Canada's decision. Similarly, the CRA's ability to collect from the Husband was reduced when the amounts were removed from the joint account.
Tax Tips – Recognizing Transfers and Avoiding Derivative Liability
The Canada Revenue Agency has many powerful tools for collecting amounts owing by taxpayers, but occasionally it seeks to use those tools in circumstances where it is not allowed to do so. As White v. The Queen demonstrates, determining whether the CRA is allowed to issue a derivative assessment under section 160 of the Income Tax Act or section 325 of the Excise Tax Act is complex and can turn on subtle distinctions. If you have significant tax arrears or have received property from a person with significant tax arrears, you should consult with an experienced Toronto tax lawyer to help you avoid a derivative assessment. Similarly, if you have been assessed under section 160 of the Income Tax Act or section 325 of the Excise Tax Act you should consult with one of our expert Toronto tax lawyers to determine how you can dispute the assessment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.