Section 160 of the Income Tax Act (Canada) (the Act) is a collection tool that the Canada Revenue Agency (CRA) may use to collect unpaid tax debts of a taxpayer from third parties. This provision applies where a tax debtor transfers property to his or her spouse (or common-law partner), a minor, or another non-arm’s length person for no consideration or for consideration less than the property’s fair market value. In these circumstances, the recipient of the property may be assessed as jointly and severally liable for the transferor’s existing tax debt under the Act at the time of the transfer, up to the value of the property received. Such an assessment may be referred to as a “derivative liability” assessment.
Section 160 is intended to prevent taxpayers from avoiding the collection of tax by transferring their property, including money, into “friendly hands” for inadequate consideration, leaving the CRA with nothing left to collect. In the 2021 budget, the federal government raised concerns that certain taxpayers are engaging in transactions designed to avoid the application of this provision. As such, Budget 2021 proposed three specific anti-avoidance rules to counter such transactions. A summary of these proposals can be found in our blog post on the Budget 2021 measures here.
Below is a review and analysis of recent developments in the Canadian courts with respect to derivative liability assessments under section 160. By way of background, the courts have made clear that in order for section 160 to apply, the following four conditions must be satisfied:
1) the transferor must be liable to pay tax under the Act at the time of transfer;
2) there must be a transfer of property, either directly or indirectly, by means of a trust or by any other means whatever;
3) the transferee must either be:
a. the transferor’s spouse or common-law partner at the time of transfer or a person who has since become the person’s spouse or common-law partner;
b. a person who was under 18 years of age at the time of transfer; or
c. a person with whom the transferor was not dealing at arm’s length; and
4) the fair market value of the property transferred must exceed the fair market value of the consideration given by the transferee.
An assessment under section 160 is capped at the debt of the transferor at the time of the transfer, meaning the transferee is not liable for subsequent debts that arise under the Act, and the liability is reduced to the extent that the transferee provides consideration in exchange for the property.
The consequences of section 160 can be harsh, as it applies regardless of whether the recipient of property was aware of the transferor’s tax debt and regardless of whether the transferor transferred the property with any intent to avoid payment of the tax debt.
Whether a section 160 assessment can be successfully appealed often hinges on one of two factual questions:
1) What was the value of the consideration, if any, provided by the transferee for the property?
2) Was there in fact a transfer of property, directly or indirectly, to the transferee?
The Tax Court of Canada and the Federal Court of Appeal have released several recent decisions dealing with these two issues, a review of which follows, following by an in-depth look at the Damis Properties case.
What was the value of the consideration?
The first finding of fact that has been the subject of recent jurisprudence is the value of consideration, if any, provided by the transferee for the property received. For example, in Valovic (2020 TCC 101) the Tax Court confirmed the longstanding view that when a corporation pays dividends to a shareholder, this constitutes a transfer of property from the corporation to the shareholder for no consideration. Any services provided by the shareholder to the corporation does not constitute consideration for the dividends received. Therefore, a husband and wife who were equal shareholders in a corporation, of which they were also employees and directors, were liable for the corporation’s debts under section 160 in an amount equal to the dividends they received. They were not liable in respect of any employment income for which consideration in the form of services was provided.
The case of Muir (2020 TCC 8) also addressed the question of whether consideration had been provided to a corporation on the distribution of cash to its shareholders. In that case, the taxpayer was the sole shareholder of a professional corporation which carried on a dental practice. All of the assets of the dental practice were sold to an arm’s length party and a portion of the sale proceeds was transferred to the shareholder so that she could distribute amounts to creditors of the corporation. The Tax Court found that section 160 did not apply as the corporation had transferred the funds to the taxpayer subject to the requirement that they be used to repay creditors. The taxpayer did not have discretion as to how she spent the funds but instead was required to use the money to settle the corporation’s debts. In other words, the settlement of these debts represented consideration provided by the shareholder to the corporation in exchange for the sale proceeds.
A similar situation arose in Brown (2020 TCC 45) where a tax debtor who was unable to open his own bank account deposited cheques directly into his spouse’s bank account. The spouse then used the funds, relying on specific instructions provided by the tax debtor on a monthly basis, to pay the tax debtor’s credit card bills and expenses. The Tax Court found that there was an enforceable contract between the tax debtor and his spouse requiring the spouse to use the funds to pay bills per his directions. The spouse’s payment of bills on behalf of the tax debtor was valid consideration equal in value to the property transferred, and section 160 therefore did not apply.
The value of consideration was again at issue earlier this year in Eyeball Networks (2021 FCA 17), this time in the context of a corporate reorganization. The facts involved a fairly common “butterfly” or “divisive reorganization” series of transactions in which the sole shareholder exchanged all his shares of a corporation, having an estimated fair market value of $30 million, for new voting shares and non-voting redeemable shares with an aggregate redemption amount of $30 million. The shareholder then transferred the redeemable shares to a new corporation (Newco) on a tax deferred basis, taking back voting and non-voting shares in Newco. The original corporation then transferred its assets (also worth $30 million) to Newco on a (partially) tax-deferred basis, for the assumption of a small liability and redeemable shares of Newco. The redeemable shares in each corporation were then redeemed for notes and the notes were set-off against one another.
The Tax Court took no issue with the transfer of the tax debtor’s assets to Newco for shares thereof. Rather, the Court found that at the time of the set-off, the fair market value of the note held by Newco was nil and therefore this transaction represented a surrender of debt without consideration, transferring a value of $30 million to Newco. As a result, the Tax Court found that Newco had properly been assessed for the transferor’s tax debt under section 160. The Federal Court of Appeal reversed the Tax Court’s decision, noting that it was not open to the judge to hold that one note had value while the other did not, as both were backed by the same assets. Since the mutual set-off of the notes had the same effect as if both notes were discharged with cross-payments, and the law was clear that a payment of bona fide debt cannot trigger the application of section 160, the appeal was allowed.
Was there a transfer of property?
The second finding of fact discussed above, what constitutes a transfer of property, has also been the subject of recent jurisprudence. For example, in White (2020 TCC 22), a tax debtor had deposited funds into a joint bank account and the Tax Court had to decide whether the deposit was in fact a transfer to the tax debtor’s spouse who was a joint holder of the account. In finding that the mere placing of funds in a joint account did not constitute a transfer to the spouse, the Court noted that the tax debtor did not divest himself of the funds and that the CRA could have taken collection action with respect to the funds in the joint account. However, when such funds were transferred to the spouse’s sole account, this represented a transfer for the purpose of section 160.
More recently in Goldman (2021 TCC 13), the Tax Court examined the existence of a trust in the context of a transfer of property. In that case, the tax debtor was the alleged transferee’s deceased mother, whose only significant asset at the time of her death was an RRSP. Prior to her death, the mother had made her daughter the designated beneficiary of the RRSP on the explicit understanding that she would use the proceeds to pay certain expenses, for example funeral costs and the costs of estate administration, and divide the remaining funds amongst all three of her daughters. The CRA assessed the daughter pursuant to section 160 in respect of the deceased’s unpaid tax debts for an amount equal to the RRSP funds received. The daughter appealed the assessment on the basis that she was simply a trustee of the RRSP proceeds, distributing the funds in accordance with her mother’s wishes. The Tax Court agreed and allowed the appeal.
The decision in Goldman touches on several other aspects of section 160, including its purpose and the draconian results it may produce. In the Muir decision, discussed above, the Tax Court recognized the harsh results that section 160 may produce and did not accept that it was the intention of Parliament to “have section 160 apply in circumstances where CRA not only wasn’t but could never be, nor did the transferor or transferee attempt to place the CRA, in any different position whatsoever as a result of the transfer”. The Court in Goldman held otherwise, stating that it is not the Court’s role to overlook the clear and unambiguous wording of section 160 in order to interpret the provision in a manner that fulfills its purpose or makes it fairer. According to the Court in Goldman, it is up to Parliament, not the courts, to address such fairness by amending the provision.
In addition, the Tax Court in Goldman addressed the Federal Court of Appeal’s obiter comments in Livingston (2008 FCA 89) that the phrase “by means of a trust or by any means whatever” in section 160 suggested that the mere receipt of legal title to property as a trustee was sufficient to trigger the application of section 160. The Tax Court disagreed with this proposition, stating that it is the trust itself which becomes the subject of a section 160 assessment, not the trustee personally. It also noted that the value of the legal title received by the trustee would simply be nothing, i.e., nil, for the purposes of determining the quantum of liability under section 160.
In this author’s opinion, the decision in Goldman opens the door for an alternative basis for allowing appeals in situations similar to that in Muir and Brown. Arguably, each of those cases may also have been decided by considering whether there was indeed a transfer of property for the purpose of section 160. In both instances the alleged “transferee” did not have discretion as to how they used the property but were merely carrying out the transferor’s instructions in receiving the funds and transferring them to the appropriate persons. In other words, it may be argued that the transferees were simply holding bare legal title to the property as trustees for the transferors, receiving no beneficial interest in the property.
The current state of section 160 was summarized extensively in the most recent decision regarding the provision, Damis Properties (2021 TCC 24), released the end of March, 2021. In the decision, the Tax Court considered a variety of issues including what constitutes a transfer of property for the purpose of the provision, whether a non-arm’s length relationship exists, what is the fair market value of the consideration provided, and whether the general anti-avoidance rule (GAAR) applies to a series of transactions that the CRA claimed abused section 160.
In Damis Properties, the taxpayers were corporations that had facilitated the sale of farmland owned through general partnerships (the Appeal was heard on common evidence with respect to five taxpayers, each of which held a 99.9% interest in one of five general partnerships holding an interest in the land) by undergoing a series of somewhat complex transactions. First, each taxpayer incorporated a wholly-owned subsidiary and transferred the partnership interest to the subsidiary on a tax deferred basis. The general partnerships then sold the farmland for cash (in two of the cases the cash was then loaned to a taxpayer or its parent company). After the sale, the proceeds were then allocated to the subsidiaries as partners of the general partnerships, and each subsidiary increased its stated capital, resulting in an increase in each taxpayer’s adjusted cost base (ACB) in the subsidiary shares by the same amount. Each subsidiary also purportedly purchased software and claimed a deduction for capital cost allowance (CCA) in respect thereof, resulting in a reduction to the subsidiary’s income from the sale of the farmland.
Subsequent to the above transactions, each taxpayer entered into a put agreement with a third party (WTC) with regard to the sale of the shares of each subsidiary. A nominee of WTC replaced the officer and director of each subsidiary and the put options were exercised, triggering the sale of each subsidiary to WTC. Sale proceeds were satisfied by WTC with the cash (and in certain cases, receivables) held by the subsidiaries. The CRA took issue and denied the CCA deductions claimed by the subsidiaries in respect of the software, resulting in a tax liability for each subsidiary under the Act.
In assessing the taxpayers under section 160, the CRA took the position that the phrase “directly or indirectly in any manner whatever” was broad enough so as to include the indirect transfer of the property, being the sale proceeds in the form of cash and receivables (the Property), from the subsidiaries to the taxpayers through WTC. Further, the CRA argued that each subsidiary did not deal at arm’s length with the relevant taxpayer (and WTC) at the time of the transfer and that each subsidiary transferred proceeds to each taxpayer in exchange for no consideration.
With respect to the GAAR, the CRA argued that the alternative transaction which was avoided, the transfer of the Property from each subsidiary to its parent taxpayer by way of a dividend, would have given rise to a section 160 assessment (see for example Valovic, above) and that the primary purpose of the transactions was to avoid such assessment. Further, the CRA argued, the avoidance of the joint and several liability to tax was a tax benefit realized by each taxpayer and the overall result of the relevant transactions was to defeat the purpose, or underlying rationale, of section 160.
Writing for the Tax Court, Justice Owen canvased the jurisprudence on the meaning of “transfer” and came to the following two conclusions in interpreting section 160: (1) the words “a person has… transferred property” require an objective determination of what has occurred, and (2) one must consider all the circumstances and determine whether it is reasonable to conclude that there is a connection between the diminishment of the property of one person and the increase in property of another person. Justice Owen then found that as a consequence of the series of transactions initiated by the subsidiaries, there was an indirect transfer of property for the purposes of section 160 because the subsidiaries ceased to hold, and the taxpayers began to hold, the Property. This conclusion was not altered by WTC’s participation in the transactions, nor the fact that WTC could have sourced funds otherwise than from the subsidiaries.
However, the Tax Court found that each taxpayer and its subsidiary were dealing at arm’s length at the time of the transfer. As such, the Court found that section 160 was inapplicable to the taxpayers (although it was noted that the CRA could have potentially pursued WTC under the provision). Justice Owen went on to consider the CRA’s argument regarding the value of consideration provided by each of the taxpayers, noting that it is clear in the words and context of section 160 that “consideration given for the property” can only mean consideration given by the transferee, in this case the taxpayers. As the taxpayers provided WTC with the shares in the subsidiaries in consideration for the sale proceeds, any liability under section 160 was thereby reduced to nil, each taxpayer having provided full credit for the consideration paid for the Property.
With regard to the GAAR, the Tax Court pointed out one major flaw in the CRA’s argument that the taxpayers had received a tax benefit: the alternative intercorporate dividend arrangement posited by the CRA was not a reasonable alternative as the subsidiaries were incorporated for the sole purpose of their being sold to WTC. In other words, the subsidiaries would not have been created absent the sale and as such there was no possibility of an intercorporate dividend between the subsidiaries and the taxpayers, WTC being the owner of all shares in the subsidiaries after the sale. The alternative transaction was therefore having the general partnership sell the farmland and distribute the proceeds to the taxpayers, in which case there would be no transfer of property for the purposes of section 160. The GAAR was therefore found not to apply and the appeal was allowed.
In reaching its decision, the Tax Court did, however, recognize that the taxpayers received a tax benefit, i.e., the increase in stated capital of the shares of its subsidiaries, resulting in the increase in ACB prior to the sale to WTC. Therefore, Justice Owen decided to address, in obiter, whether there was an avoidance transaction, and whether such avoidance was abusive.
With regard to the first of these two questions, Justice Owen noted that the CRA had not pointed to any transaction which would indicate avoidance of section 160. Based on the evidence, he was of the view that the taxpayers had no intent to avoid section 160 by undertaking the transactions, despite the fact that the transactions may have been implemented to achieve some other tax benefit. Justice Owen noted that the GAAR analysis must focus on the tax benefit alleged by the CRA and not some other tax benefit.
Finally, in determining whether section 160 was abused, Justice Owen noted that the purpose of the provision is not simply to collect amounts owing so that the CRA’s collection actions are not thwarted, but rather to vet transfers of property between non-arm’s length persons and to collect from the transferees any enrichment resulting from the transfer (to the extent of the tax amount owed by the transferor). Since the property in this case was transferred, indirectly, to an arm’s length person, and the transferee received no enrichment from the transfer, Justice Owen found no abuse of section 160.
The Crown has since appealed the Tax Court’s decision in Damis Properties to the Federal Court of Appeal and we will continue to monitor this case with interest.
The author would like to thank Jennifer Flood for her assistance in editing this blog.