By Dale Barrett – Managing Partner at Barrett Tax Law, Founder of Lawyers & Lattes Legal Cafe, Author of Tax Survival for Canadians: Stand up to the CRA, Editor of the Family Law and Tax Handbook, and Tax Columnist at the Lawyer’s Daily. Originally published by The Lawyer’s Daily.
Most people don’t think twice before transferring assets between family members. Why would they? People deposit money into each other’s accounts. They put each other’s names on their properties in order to get mortgages. They sell assets to one another for one dollar. They move closely held company shares back and forth. And they inadvertently create massive tax problems for themselves, some of which are impossible to fix.
Sometimes as a result of such transfers and transactions, people create capital gains tax debts which otherwise would not have existed, and other times people are forced to pay a related party’s tax debt, which normally would not have been collectible against them.
What most people are not aware of is that there exist provisions in Canadian tax legislation which act to prevent non-arm’s length parties (spouses, siblings, parents and their children) from contracting with one another freely by deeming non-arm’s length transactions to occur at fair market value, and other provisions which penalize people for the transfer of property to one another under certain conditions.
Subsection 160(1) of the Income Tax Act and ss. 325(1) of the Excise Tax Act are powerful collections tools used by the CRA to ensure that tax debtors do not artificially impoverish themselves to the detriment of their ability to pay taxes owed to the CRA. These provisions accomplish their goal by punishing the recipient when assets are transferred by tax debtors to related persons (including corporations) or when assets are sold by tax debtors to related persons for less than fair market value.
These provisions provide that the transferor and the transferee are jointly and severally liable for the payment of the tax of the transfer or up to the amount of the benefit received by the transferee. For example, if a car worth $20,000 is transferred from one spouse to another for consideration of one dollar, then the transferee received a benefit of $19,999 in this transaction, and thus can be held liable to pay $19,999 towards the tax debt of the transferor.
There was a case of an elderly retired woman who gave her son a bank card (from a disused account) to use because his accounts were frozen and thus he didn’t have anywhere to deposit his paycheque. Over three years he deposited $150,000 of his pay into his mother’s bank account. He in turn withdrew all the money and used it for his living expenses.
It was argued in court that the mother didn’t receive any benefit from the money deposited into her account because $150,000 went in, and $150,000 went back out to her son.
The judge disagreed. At the moment the funds were deposited, a non-arm’s length transfer had taken place. And while the son received all his money back (in the absence of an agreement to return the money or a trust agreement), the money he received in return for the deposits was seen by the court as a gratuitous gift, rather than as consideration. Had it been seen as consideration, then the mother would have paid $150,000 consideration for the transfer of $150,000, which would have left her with no “benefit” and no liability for his tax.
Instead, since the court viewed this case as a non-arm’s length transfer for no consideration followed by a gift, the ss. 160(1) assessment against the mother was upheld. Sadly, she ended up having to pay $150,000 towards her son’s tax debt which depleted her retirement account.
The scarier, hidden danger is when one receives a non-arm’s length transfer of property from an individual who at the time of transfer is not a tax debtor. In such a case, even if the transferee verified that the transferor had no tax debt at the date of transfer, at some point in time after the transfer is concluded the CRA could possibly reassess the transferor for a tax year prior to the transfer.
The resulting tax liability from this reassessment is deemed to have occurred retroactively and would thus pre-date the transfer. This means that at the date of transfer, the transferor actually would been retroactively considered to be a tax debtor. And if the transferor does not pay the tax debt the CRA can go after the transferee even though they had done their due diligence at the time of the transfer.
Besides the collections tools at the CRA’s disposal there are other provisions dealing with non-arm’s length transactions which accomplish different objectives. Subsections 69(1) and (2) of the Income Tax Act deem that if the price paid by a recipient for an asset transferred to them by a non-arm’s length transferor exceeds the asset’s fair market value, the recipient is deemed to have acquired the asset at fair market value, and conversely, if the transferor receives less than fair market consideration for said asset, they are deemed to have received proceeds of disposition equal to fair market value.
There are a number of reasons for the existence of these provisions. One such reason is that they prevent parents from selling the cottage to their kids at the price they paid (thus avoiding capital gains tax), and prevents the kids in turn 50 years later from selling that same cottage to their kids. In essence it ensures that capital gains tax will eventually be paid when a property (except a principal residence) passes from generation to generation. Without the provision, the CRA could be indefinitely deprived of capital gains tax where a property keeps being sold from generation to generation for the original purchase price.
One of the big issues with these provisions is the collateral damage: sometimes they inadvertently catch unintended taxpayers. For example, when children cannot qualify for a condo mortgage on their own, they routinely put their parents on title with them, even though the parent never contributes towards the down payment or the mortgage payments, and even though the parent is on title as a convenience and not because of actual ownership. In such cases, when it comes time later on to remove the parent from title, a couple of different issues arise.
On one hand, if the parent owes a tax debt to the CRA, the child is often assessed under ss. 160(1) ITA or ss. 325(1) ETA as a result of having received a transfer of half a condo for no consideration. On the other hand, the CRA sometimes likes to assess capital gains tax against the parent for having sold a 50 per cent share in a condo — even though the share of the condo was sold for one dollar or gifted back to the child for $0 consideration.
When such a condo was worth $200,000 at purchase and $500,000 at time of transfer, even though there was no (or minimal) consideration provided for the transfer, the CRA deems that the sale of the share of the condo was made at fair market value (or $250,000 — half of the $500,000 fair market value), and a capital gain of $150,000 is triggered against the parent.
So, if you are contemplating the transfer of an asset to a family member or another related party as defined by tax legislation, it is important to seek legal advice and to consider all the unintended tax consequences which may result.