Introduction: Vicarious Income-Tax Liability for Receiving Property from a Tax Debtor
Generally speaking, if you receive property from a person with income-tax debt, the Canada Revenue Agency can pursue you for those tax debts. Section 160 of the Income Tax Act gives the CRA a means of chasing a person for the tax debts of a related party from whom that person has received property. (The Excise Tax Act contains an analogous rule applying to those who receive property from a person with GST/HST debts.)
By retaining our Canadian tax law firm, our individual Client managed to escape $250,000 in derivative tax liability arising under section 160 of the Income Tax Act. The Client's case appeared doomed to fail. It seemingly typified the very transaction that section 160 aimed to capture: The Client had, without giving any consideration, received title to a commercial property from her mother, an individual with over $1 million in income-tax debt. Yet our Certified income-tax Specialist lawyer established a nuanced, comprehensive legal position that ultimately proved successful despite the Client's unfavourable facts. As a result, the Canada Revenue Agency's Appeals Division vacated the Client's $250,000 assessment.
After reviewing section 160 of the Income Tax Act, this article examines the Client's case, the strategy we implemented, and the results achieved. We then offer some tax tips based on this case study.
Derivative Income-Tax Liability under Section 160 of the Income Tax Act
Section 160 of the Income Tax Act expands the Canada Revenue Agency's power to collect income-tax debts, and it aims to prevent taxpayers from keeping assets away from CRA tax collectors by transferring those assets to friends or relatives.
The rule applies if four conditions are met: First, a property was transferred. Second, at the time of the transfer, the transferor had income-tax debts. Third, at the time of the transfer, the recipient was any of the following: (a) the transferor's spouse or common-law partner (including a person who has since become the transferor's spouse or common-law partner); (b) a person under 18 years of age; or (c) a person with whom the transferor wasn't dealing at arm's length (e.g., a business partner, a friend, or a trust or corporation in which the transferor has an interest). Finally, the recipient paid the transferor less than fair market value for the transferred property.
If section 160 applies, the recipient and the transferor become "jointly and severally" liable for the transferor's income-tax debts. This means that the recipient becomes independently liable for whatever tax debt the transferor had at the time of the transfer. In consequence, the CRA's tax collectors can then attempt to collect the tax debt from each the original tax debtor and the recipient. What's more, the recipient remains liable for the tax debt even if the original tax debtor goes bankrupt, gets discharged, and is released from all debts to the Canada Revenue Agency.
Section 160 is admittedly harsh. 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. It even applies retroactively when a transferor has no tax liability at the time of transfer but is subsequently assessed for taxes. Moreover, liability doesn't come with a limitation period. So, the CRA can assess you for derivative tax liability years after the purported transfer.
That said, the recipient's liability under section 160 is capped at the fair market value of the transferred property, and the liability is further reduced by the value of any consideration that the recipient paid for the property.
Subsection 160(3) governs the application of payments toward the joint liability. If the payment is made by the taxpayer who inherited the liability under section 160, it reduces both debts—in other words, it reduces not only the tax debt of the jointly liable taxpayer but also the tax debt of the original tax debtor. On the other hand, if the payment is made by the original tax debtor, it reduces only those tax debts that belong solely to the original tax debtor; the payment reduces the joint debt only if the original tax debtor has first paid off all other tax debts.
The Client's File: Under CRA Garnishment for $250,000 in Derivative Tax Liability & Expiry of 90-Day Objection Deadline
The Client's parents initially consulted one of our Canadian tax lawyers and explained how some poor tax advice had now put their children at the mercy of CRA tax collectors.
Several years ago, the Client's mother approached her accountant for creditor-protection advice because she had amassed over $1 million in personal income-tax debt relating to her sole-proprietor business. Although lacking any legal expertise and thus unqualified to provide this sort of advice, the accountant entertained the request. He told the Client's mother to take her name off title for a commercial property that he owned and make her children the sole joint titleholders of that property. The accountant assured her that the title change would insulate the property from her liabilities—despite her intention to retain all benefits associated with owning the property and her having no desire to divest ownership of the property in any way.
So, in 2008, relying on what she thought was good advice, the Client's mother took her name off title and made her son and her daughter, the Client, the joint titleholders of the property.
The title change triggered a predictable response from the Canada Revenue Agency's tax collectors. The CRA assessed the Client and her brother each under section 160 of the Income Tax Act. In the summer of 2013, the CRA assessed the Client's brother for $250,000 in derivative tax liability. Then, in late 2017, the CRA assessed the Client for another $250,000 in derivative tax liability. (The CRA had appraised the value of an unencumbered beneficial interest in the commercial property at approximately $500,000. The assessed $250,000 represented the value of a 50% beneficial interest in the property.)
Unfortunately, when the Client and her brother received their respective assessments, they asked their mother's accountant what to do. The accountant made matters worse by telling them that they could ignore the assessments if their mother entered a payment arrangement with the CRA with respect to her own $1 million tax debt. Basically, the accountant failed to understand the significance of the "joint and several" tax liability arising from an assessment under section 160. In fact, the CRA sought to collect tax debts not only from the Client's mother but also from the Client and her brother. And even though her mother negotiated a payment arrangement with the Canada Revenue Agency for her own $1 million tax debt, the CRA's tax collectors still garnished the Client's wages.
In addition, the accountant neglected to explain their tax-appeal rights, the time limits on exercising those rights, and the consequences of failing to exercise those rights. So, by the summer of 2018, when the Client consulted with our Canadian tax lawyers, the normal 90-day objection deadline for her section 160 assessment had expired. But she did still have time to file an extension-of-time application. Her brother was less fortunate, however. His appeal rights had completely expired.
Our Strategy: A Nuanced, Comprehensive Tax-Law Position
In response to the Client's section 160 assessment, our knowledgeable Canadian tax lawyers filed an extension-of-time application and notice of objection.
Granted, the Client's case presented no easy solution. It typified the very transaction that section 160 seemingly aimed to capture: The Client had, without giving any consideration, received title to a commercial property from a related party with over $1 million in income-tax debt.
But, through exhaustive legal research, our Canadian tax lawyers prepared a notice of objection that challenged each element of the Client's section 160 assessment.
We relied primarily on four arguments. First, the commercial property wasn't "transferred" to the Client in the sense contemplated by section 160 because her mother hadn't divested ownership. Second, even if a transfer did occur, the CRA valued the wrong property when computing the Client's derivative tax liability: The CRA based the Client's $250,000 assessment on a valuation of the right to unencumbered beneficial ownership of the property, yet the Client received bare legal title without any beneficial interest, and this property interest has nominal value. Third, even if the transferred property had some value, the Client gave consideration of equal value by agreeing to act as her mother's agent. And finally, the CRA failed to adduce evidence establishing the correctness of the tax debt underlying the Client's section 160 assessment (i.e., the tax debt of the Client's mother).
The Outcome: Success Based on Tax-Law Expertise & An Aggressive Approach with the CRA's Appeals Division
The CRA's Appeals Division initially disagreed with our position and insisted on confirming the Client's assessment. But our skilled Canadian tax lawyers dismantled every argument that the CRA appeals officer put forth. We explained how the CRA had cited incorrect case law by confusing the notions of a bare trust and agency, on the one hand, with the notion of a resulting trust, on the other. We pointed out where the appeals officer had conveniently ignored evidence and law proving unfavourable to the CRA's position. We laid bare the inconsistent premises underlying the appeals officer's arguments. We rebuffed the appeals officer's attempt to thwart his duty to adduce evidence showing that the underlying tax debt was indeed correct. And when it later became apparent that the CRA appeals officer might not conduct an impartial review, we demanded a conversation with his team leader and his team leader's manager.
Our relentless approach paid off. A few hours before our scheduled discussion with the team leader and manager, the appeals officer contacted our tax-law firm and explained that the CRA's Appeals Division would allow the Client's objection in full.
The Canada Revenue Agency's Appeals Division vacated the Client's section 160 assessment—thereby eliminating the Client's $250,000 in derivative tax liability.
Tax Tips – Vicarious Income-Tax Liability & The Value of Consulting an Experienced Canadian Tax Lawyer
The Client's file demonstrates the value of an early consultation with a Certified Specialist Canadian tax lawyer. The Client approached us just in time for our Canadian tax lawyers to extinguish her $250,000 derivative income-tax liability. Her brother, however, wasn't as fortunate. Because his appeal rights had expired long before our firm's involvement, he remains personally liable for the $250,000 resulting from his own section 160 assessment.
If you want to dispute a notice of assessment or reassessment—including an assessment under section 160—the Income Tax Act requires that you file a notice of objection within 90 days from the date on the assessment. If the normal 90-day deadline expires, you must apply for an extension in accordance with section 166.1. The extension-of-time application must explain why you failed to file the objection within the normal time limit, and it must demonstrate that it would be just and equitable for the CRA to grant the application. You must apply within a year of the date that the 90-day objection deadline expired. If you satisfy the extension-of-time requirements, the CRA has the discretion to grant the extension and consider your objection. Like the objection itself, the extension-of-time application requires legal arguments. Our Canadian tax lawyers have prepared countless successful extension-of-time applications.
The Client's case also shows why you shouldn't assume that you've dodged liability under section 160 because several years have elapsed since you received the transfer, gift, or inheritance from a tax debtor. Section 160 doesn't come with a limitation period. So, the CRA can assess you for derivative tax liability years after the purported transfer. In the Client's case, the alleged transfer occurred in 2008, and her brother received a section 160 assessment in 2013. Yet the Client was assessed in 2017, three years after her brother's assessment and nine after the impugned transfer!
So, if you've been assessed under section 160 because you received or inherited assets from someone with tax debts, if you believe that you could be assessed under section 160 because you inherited or received assets from someone with tax debts, or if you're concerned that section 160 might cause your loved ones to inherit your tax debts, speak with one of our experienced Canadian tax lawyers. We thoroughly understand this area of law, and we can ensure that your response to the Canada Revenue Agency is forceful, thorough, and cogent.
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.