Transferring tax debt between parties
On January 10th, the Tax Court handed down a decision in the appeal Scott v The Queen. This has some interesting comments on issues that affect our clients every day.
Here, the Taxpayer’s brother racked up a significant tax debt, for reasons that he described as involving a change in the CRA’s administrative policy for taxing Canadian flights of commercial pilots. The pilot brother then sent the taxpayer in this case a significant amount of money. The Court could not determine exactly why the taxpayer’s brother these funds; the taxpayer’s brother described it as a loan, but the Court noted some inconsistencies in his testimony and a lack of documentary evidence.
CRA has several mechanisms to “chase” tax debts when one person accrues a balance and does not pay it (often referred to as third-party or derivative assessments). One of these is Section 160, the primary mechanism for pursuing personal or corporate income tax debts between parties. Where someone owing tax debt transfers property to someone with whom they do not deal at arm’s length, the recipient is jointly-and-severally-liable for the original tax debtor’s taxes for the year of the transfer and prior years, up to the value of that property less any consideration. Once the CRA has assessed the recipient, they both pay from the same “pool” of tax; CRA can enforce the full balance of the debt against either of them, and a payment by one taxpayer reduces the amount owing by the other (where the debt is capped by the value of the property received, rather than the tax owing, the original tax debtor’s payments go towards the other portion first).
These assessments are very common. The provision prevents tax debtors from avoiding collection by giving away their assets to friends, families, or from shifting a business and its assets to a new company. It covers a very broad range of transactions, among the most common of which are dividends, appropriations of cash from companies, and gifts to family members.
In this case, the CRA assessed the taxpayer for the brother’s debt in 2015. It later waived some interest on the brother’s tax debts in 2016. The CRA did not apply this waiver to the taxpayer’s assessment. The taxpayer contested the assessment, arguing that it was a loan from his brother.
Because the taxpayer generally needs to prove the government wrong to win a tax dispute, it can be very difficult to succeed while concealing information, particularly in the absence of documentation. Convincing the Court that something unusual happened (for example, your brother loaning you $224,500 without a written contract or fleshed out terms) requires a thorough explanation of context and motivations, and in its absence the Court consistently draws adverse inferences.
In a footnote, the Court noted that it did not agree that the recipient of money from a tax debtor could respond to a Section 160 assessment on the grounds that it only received a loan. While it was not necessary to dispose of the appeal, this is a divergence from prior opinions of the court (e.g. Merchant, 2005 DTC 377) concluding that a loan is not a “transfer” of property. A recipient of a loan could also argue that in exchange for money they borrowed, they provided consideration in the form of a promise to repay.
We strongly encourage individuals loaning money between family members, particularly when loaning money to potential tax debtors, to paper this agreement, even informally, and keep a copy available. When dealing with repayments of loans, the Tax Court and CRA are somewhat flexible regarding the substance of loans repayment of which can count as a transfer for full consideration for Section 160 purposes. However, without something in writing, you can end up spending a lot of time and money convincing that the loan existed in the first place.
The case is also interesting because it includes a discussion of the effects of the CRA waiving interest. The CRA waived interest on the transferor brother’s taxes but did not apply this same waiver to the transferee—and so the transferee brother actually owed more than the original tax debtor.
From a quick review of prior decisions, it’s not clear that the Tax Court has addressed this issue previously. However, the Court reached what we see as the only sensible conclusion and required the CRA to apply the interest relief to the taxpayer’s account. Section 160 and related decisions are fundamentally collections mechanisms, and do not create tax liability in-and-of themselves.
There is some ambiguity surrounding the provision that discusses the value of the liability (specifically, 160(1)(e)(ii)), but the transferee’s liability is determined with reference to the transferor’s liability in the present tense (in contrast to the provision relating to the value of the transfer). The CRA and Courts also allow later assessments of prior years to affect the transferee’s liability (see, e.g. Ingrao v MNR,  1 C.T.C. 2052 (TCC)). In our view, the Court came to the only reasonable conclusion.
– James Alvarez, Tax Counsel
© Kalfa Law 2020