As the world struggles with COVID-19, and small and medium businesses endure the worldwide economic slowdown, directors of Canadian corporations need to know about the long arm of the CRA when it comes to ensuring that GST net tax obligations and ITA source withholding requirements are met by corporations!
One particularly egregious collections power that the CRA has is its ability to issue so-called derivative assessments to relatives of taxpayers who have received money, property or dividends from the corporate tax debtor, at a time that the corporation or the director are liable for tax.
A “derivative assessment” refers to an assessment whereby the CRA collects from a third party an amount owing that it is unable to collect from the taxpayer. Where a tax debtor transfers property to a non-arm’s length party for less than fair market value (FMV) consideration, section 325 of the Excise Tax Act (ETA) and section 160 of the Income Tax Act (ITA) may apply to allow the CRA to assess the transferee personally.
These provisions are often used in conjunction with another type of derivative assessment – the director’s liability provisions at section 323 of the ETA and section 227.1 of the ITA. This means that where a corporate director makes a below-FMV transfer to a related party at a time that the corporation has an outstanding tax liability, both the director and the related party can be personally assessed in connection with that liability.
(A typical example might be a director, faced with a corporate tax debt, selling her interests in the matrimonial home to her husband for $1, or transferring personal bank account funds to her husband’s account.)
This was effectively the situation that arose in a recent Tax Court of Canada (“TCC”) case, White v. The Queen (2020 TCC 22). A corporation went out of business in 2006 but still had net tax owing. In August 2009, its director, Mr. White, was assessed personally for the tax debt owing by the corporation. Mr. White subsequently obtained new employment and between March 2013 and March 2014, he deposited $89,806 of employment earnings into his joint bank account with his wife. In March 2016, the CRA assessed the wife in respect of the amounts deposited by Mr. White into the joint back account with his wife.
The matter was ultimately appealed to the TCC, where the Court concluded that the deposits into the joint bank account were not in themselves “transfers” for the purposes of ETA section 325 / ITA section 160 (because Mr. White continued to have full access to the funds and therefore had not divested himself of the funds), BUT did conclude that a “transfer” did occur the moment the funds were withdrawn by the wife for her own benefit. These included (1) transfers from the joint bank account to the wife’s own bank account, (2) transfers from the joint bank account to the wife’s line of credit account, and (3) mortgage payments drawn from the joint bank account in respect of a home owned solely by the wife.
Although the wife succeeded in her appeal, this case raises alarming potential issues. For example, consider a situation where a director is liable for the corporation’s default, and continues to support his family by buying groceries. Are these sorts of payments assessable?
Recognizing a spouse’s obligation to support his or her family, the courts have in some cases allowed for a narrow exception for “vital household expenses” that fall outside the reach of ETA section 325 / ITA section 160. However, what is the proper dividing line for determining what constitutes a “vital household expense”?
Directors in these situations should seek out specialized tax advice lest they end up surprised by an unexpected assessment.
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