According to subsection 159(1) of the Income Tax Act (the "Act"), legal representatives jointly and severally, or solidarily liable for a taxpayer's tax liability while they are the legal representative, to the extent that the legal representative is at that time in possession or control of property that belongs or belonged to the taxpayer or their estate.
The Canada Revenue Agency (the "CRA") recently released Technical Interpretation 2006-0638171E5 (the "Interpretation") considering a legal representative's liability pursuant to subsection 159(1) of the Act. In the Interpretation the CRA interpreted what is meant by "that time."
The Interpretation is quite alarming as it appears to suggest legal representatives such as executors or trustees could be personally liable for a tax debt the legal representative did not know about as a result of exercising their proper responsibilities.
The CRA considered the following scenario:
- A trust whose sole individual beneficiary has an unpaid tax liability for 2014 holds marketable securities with a fair market value ("FMV") of $125,000 on December 31, 2016.
- The Trustee is the legal representative for the beneficiary for the purposes of section 159 of the Act.
- The beneficiary filed his 2014 tax return and was assessed $150,000 outstanding tax liability on April 30, 2015.
- Due solely to market decline, on April 30, 2015 the portfolio had a FMV of $100,000.
- On January 1, 2016 the CRA issued the Trustee a demand notice for the beneficiary's tax debt.
- On January 7, 2016 the Trustee sold the portfolio and, again due solely to market decline, was only able to obtain $70,000.
The CRA concluded that the wording of section 159(1) was such that "that time" is the time an amount becomes payable, being April 30, 2015 – despite the fact that at this point no demand for payment had been made to the Trustee and there is no indication that the Trustee had any way of knowing of the beneficiary's tax liability.
The Trustee could therefore be personally liable for the $30,000 loss in value between April 30, 2015 and the sale in January 2016.
Problems with interpretation for legal representatives:
The Interpretation is alarming for a couple of reasons.
First, a legal representative may not learn of that tax liability until after it is payable. This could occur when the legal representatives responsibilities do not include being responsible for the tax compliance of the person they represent, or, even when they are responsible for tax compliance, in the case of a late filed return or a later reassessment.
Second, the Interpretation appears to suggest that a legal representative could be personally liable for reductions in the value of the assets as a result of properly carrying out their fiduciary obligations as legal representatives – this could include not just as a result of market changes from investing as in the Interpretation but even potentially as a result of paying other creditors.
Advice going forward:
Unfortunately, there do not appear to be any perfect answers – it is far too easy to imagine circumstances where there is tax liability a legal representative has no way of knowing about and the legal representative cannot liquidate all the assets and turn them into cash and/or must pay other creditors or risk breaching their fiduciary duties.
That being said, the Interpretation highlights that tax compliance should be of primary concern to a legal representative. Tax returns should be filed prior to when tax payments are due when possible and as soon after when not possible. Tax liabilities should be paid promptly and on a timely basis. It also may make sense for an executor to obtain a clearance certificate for the deceased even if they are not yet ready to obtain one for the estate to reduce the risk that there is outstanding tax liability the executor is unaware of.
It is also worth noting that this will likely only be a problem when the trust or estate does not have sufficient assets to cover the tax liability as, in all likelihood, a legal representative could be compensated from the trust or estate, provided the trust or estate had sufficient assets.
Finally, on a positive note, the CRA does not appear to date to be aggressively using subsection 159(1) to assess legal representatives for other's tax liability. Given the important role legal representatives play in our society, hopefully this won't change.
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.