Shareholder Liability For Corporate Tax

OVERVIEW

As a general rule, a taxpayer is only responsible for his or her own taxes. There are, however, special rules that apply in the case of non-arm's length transfers of property. An individual who receives property, whether directly or indirectly, in a non-arm's length transaction, can become jointly and severally, or solidarily, liable for the transferor's outstanding taxes as at the date of the transfer if the transfer occurs at less than the fair market value of the property (Section 160). This rule also applies to shareholders who receive dividends from companies with which they do not deal at arm's length.

Section 160 is intended to prevent a taxpayer from rendering himself judgment-proof by transferring his property to, inter alia, persons with whom he does not deal at arm's length. Its reach, however, is longer than its intended purpose, and can catch innocent shareholders who receive dividends from a family corporation.

THE RULE IN SUBSECTION 160(1)

Subsection 160(1) is as follows:

Where a person has, on or after May 1, 1951, transferred property, either directly or indirectly, by means of a trust or by any other means whatever, to

the person's spouse or common-law partner or a person who has since become the person's spouse or common-law partner, a person who was under 18 years of age, or a person with whom the person was not dealing at arm's length, the following rules apply:

the transferee and transferor are jointly and severally liable to pay a part of the transferor's tax under this Part for each taxation year equal to the amount by which the tax for the year is greater than it would have been if it were not for the operation of sections 74.1 to 75.1 of this Act and section 74 of the Income Tax Act, ... in respect of any income from, or gain from the disposition of, the property so transferred or property substituted therefor, and the transferee and transferor are jointly and severally liable to pay under this Act an amount equal to the lesser of the amount, if any, by which the fair market value of the property at the time it was transferred exceeds the fair market value at that time of the consideration given for the property, and the total of all amounts each of which is an amount that the transferor is liable to pay under this Act in or in respect of the taxation year in which the property was transferred or any preceding taxation year, but nothing in this subsection shall be deemed to limit the liability of the transferor under any other provision of this Act. There are four essential conditions for the subsection to apply:

There must be a transfer of property. At the time of the transfer, the transferor and the transferee are not at arm's length with each other. For example, the transferee is the transferor's spouse, common-law partner,1 a person under 18 years of age, or any person with whom the transferor was not dealing at arm's length.2 The transferor was liable for tax at the time that he, she, or it transferred the property. The fair market value of the property transferred exceeded the fair market value of the consideration that the transferee gave to the transferor at the time of the transfer.3 For example, an individual who transfers his family home that he owns outright to his spouse, or common law partner, when he owes taxes to the Canada Revenue Agency ("CRA"), renders the spouse or partner potentially liable for the unpaid taxes, to the extent of any shortfall in consideration on the transfer. The CRA can proceed against the transferee spouse for the shortfall. Even the tax debtor's bankruptcy does not discharge the transferee's liability.4

Where the husband and wife jointly own the property (such as the family home), the value of what the wife receives on the transfer is usually reduced by 50 per cent.5 However, in common law, joint tenancy of property is a form of ownership where two or more persons share equal ownership of their property, and have equal, undivided interests therein. Thus, in effect, each of the joint tenants has 100 per cent ownership of the property. In theory, subsection 160(3.1) would not apply to allocate the proportional interests of joint tenants in these circumstances. Tax courts, which usually interpret the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) fairly literally, generally overlook this peculiar aspect of the common law of property.

PURPOSE OF RULE

Section 160 is an anti-avoidance provision to prevent taxpayers from divesting assets into friendly hands in order to escape their outstanding taxes.6 Although the purpose of the rule is to prevent defrauding the Minister by transferring property to non-arm's length parties, the rule is applied strictly without proof of any intention to defraud.7 Although the rule works reasonably well when the CRA uses it to attack delinquent taxpayers who are attempting to circumvent their outstanding tax liabilities, it can have unexpected consequences for those who do not fully understand its reach.

STRICT LIABILITY

Section 160 is a strict liability provision that applies regardless of any intention on the part of the transferor to avoid taxes.8 There is no due diligence defense.9 The provision is not interpreted according to its "object and spirit". The transferee's lack of knowledge of the transferor's tax debt is does not negate liability.10

The transferee remains liable even if he, she, or it returns the transferred funds to the transferor, unless the re-transfer of the property is a valid disclaimer of the gift.11 Indeed, where a corporation confers a benefit on its shareholder under subsection 15(1) both the shareholder and the corporation can be liable for taxes resulting from the transfer.12

MEANING OF TRANSFER

"Transfer" is broadly interpreted to include virtually any kind of transaction that involves the passage of property, including gifts...