Published: May 6, 2022
Last Updated: November 7, 2022
Introduction – Derivative Tax Liability under Section 160 of Canada’s Income Tax Act & Dividends from Tax-Debtor Corporations
Section 160 of Canada’s Income Tax Act is a tax collection tool. It thwarts taxpayers who try to hide assets from the Canada Revenue Agency’s tax collector by transferring those assets to friends, relatives, related corporations, or shareholders.
Section 160 captures a broad range of transactions, including dividend payments. The Tax Court’s decision in Kufsky v The Queen, 2019 TCC 254, illustrates that, if you receive a dividend from a corporation that has outstanding income-tax debts, section 160 allows the CRA’s tax collectors to chase you for that corporation’s income-tax debt. If the amount of the dividend is less than the corporation’s income-tax debt, your derivative tax liability is capped at the amount of the dividend. You can also reduce the derivative tax liability by showing that you provided consideration for the asset that you received from the tax debtor. But in Kufsky, the Tax Court makes it clear that this this strategy won’t work for a shareholder who received dividends from a tax-debtor corporation because “the right of a shareholder to receive a dividend flows from his or her status as a shareholder and not from any consideration that the shareholder may have given.”
This article first examines the mechanics of section 160 of Canada’s Income Tax Act. It then discusses the Tax Court’s Kufsky decision and offers pro tax tips from our top Canadian tax lawyers on avoiding and disputing section 160 assessments.
The Mechanics of Section 160 of Canada’s Income Tax Act
Section 160 applies if all the following four conditions are satisfied:
- A property was transferred. The language of section 160 contemplates a broad range of transfers: it covers situations where a tax debtor “transferred property, either directly or indirectly, by means of a trust or by any other means whatever.”
- At the time of the transfer, the transferor owed a tax debt to the Canada Revenue Agency.
- The recipient was, at the time of the transfer, one of the following: (a) the transferor’s spouse or common-law partner (or a person who has since become the transferor’s spouse or common-law partner); (b) a person who was under 18 years of age; or (c) a person with whom the transferor was not dealing at arm’s length—e.g., a trust or corporation in which the transferor has an interest.
- The recipient paid the transferor less than fair market value for the transferred property.
In other words, section 160 will catch a transaction whereby you received assets from a related party with outstanding tax debts, and you didn’t provide full consideration in return—e.g., a dividend from a tax-debtor corporation, a gift of cryptocurrency or non-fungible tokens from a friend or relative with tax debts, etc.
When section 160 applies, the transferor and the recipient both become “jointly and severally” liable for the transferor’s tax debt. As such, the recipient becomes independently liable for the transferor’s tax debt at the time of the transfer. This means that the Canada Revenue Agency’s tax collectors can now pursue both the original tax debtor and the derivative tax debtor for the tax debt. In fact, even if the original tax debtor is later discharged from bankruptcy and thereby released from the underlying tax debt, the derivative tax debtor remains liable to the CRA until the tax debt is fully repaid (e.g.: Canada v Heavyside, ibid.)
Section 160 is a notoriously harsh rule: It offers no due-diligence defence, it applies even if the transaction wasn’t motivated by tax avoidance, and it catches transferees who don’t even realize that they’re receiving property from a tax debtor (e.g., see: Canada v Heavyside, 1996 CanLII 3932 (FCA), at para 3). In addition, section 160 doesn’t contain a limitation period. So, the Canada Revenue Agency can assess you under the rule years after the purported transfer. Section 325 of the Excise Tax Act contains a similar rule relating to derivative liability for GST/HST debts. Hence, section 160 of the Income Tax Act bestows derivative income-tax liability for transfers by a person with income-tax debts; section 325 of the Excise Tax Act bestows derivative GST/HST liability for transfers by a person with GST/HST debts.
Still, there are a few limits to the transferee’s derivative tax liability. The transferee’s derivative tax liability under section 160 is capped at the fair market value of the transferred property. The recipient’s liability is also offset by the amount of any consideration that the recipient provided for the property. Say, for example, that a corporation owes $1 million in tax debt to the CRA, and it pays a $25,000 dividend to a shareholder, and it pays another $25,000 in salary to an employee. The shareholder’s derivative liability under section 160 is $25,000—i.e., the value of the dividend. The employee, however, doesn’t incur any derivative liability under section 160 because the employee provided consideration for the $25,000 salary—namely, the employee’s services.
Subsection 160(3) governs how payments apply to discharge the joint liability. A payment by a taxpayer who has inherited liability under section 160 will reduce both debts—that is, this payment reduces not only the tax debt of the jointly liable third-party taxpayer but also the tax debt of the original tax debtor. But an ordering rule governs a payment by the original tax debtor. The original tax debtor must first pay off all tax debts exceeding the joint debt. In other words, before her tax payments can discharge the joint debt, the original tax debtor must first pay off all tax arrears belonging solely to her. Only then can the original debtor’s payments extinguish the joint debt.
Kufsky v The Queen, 2019 TCC 254: Shareholder Falls Prey to Derivative Tax Liability Stemming from Dividends
Michelle Kufsky and her husband owned and operated a corporation that provided services in interior-home decorating.
The business initially proved fruitful. But following the 2008 financial crisis, the corporation’s performance took a turn for the worst, and the corporation ultimately ceased operations with outstanding income-tax debts relating to its 2008 and 2010 taxation years.
Although it struggled financially, the corporation still managed to pay Mrs. Kufsky $85,000 in dividends during its final years. The corporation issued T5 slips reporting that it had paid Mrs. Kufsky a $35,000 dividend in 2009, a $15,000 dividend in 2010, and a $35,000 dividend in 2011.
Attempting to collect upon the corporation’s sizeable tax bill, the Canada Revenue Agency invoked section 160 of the Income Tax Act and assessed Mrs. Kufsky for $68,615.69 in derivative tax liability relating to the dividends that she received from her corporation.
Mrs. Kufsky’s Canadian tax-litigation lawyer disputed the section 160 assessment by appealing to the Tax Court of Canada. Mrs. Kufsky’s Canadian tax counsel made three alternative arguments as to why Mrs. Kufsky wasn’t liable under section 160. The Tax Court rejected each one.
Mrs. Kufsky’s first argument was that she provided consideration for the dividends that she had received from the corporation. In particular, Mrs. Kufsky argued that the corporation owed her salary payments for the years in which she received the dividends, and that she effectively received the dividends in lieu of her salary. Making quick work of this argument, the court cited its own previous decisions and the Supreme Court of Canada’s decision in Newman v Minister of National Revenue,  1 SCR 770. The court explained that, in Newman, “the Supreme Court of Canada held that the payment of a dividend relates to the entitlement of the shareholder to a capital interest in a corporation and not to any other consideration the corporation may receive from the shareholder.” And the Tax Court itself had dealt with this issue in several appeals, consistently deciding that “the right of a shareholder to receive a dividend flows from his or her status as a shareholder and not from any consideration that the shareholder may have given.”
Mrs. Kufsky’s second argument was that the dividends could not have occurred because they contravened Ontario’s corporate law. Subsection 38(3) of Ontario’s Business Corporations Act prohibits a corporation from paying a dividend if the corporation is insolvent or if the dividend payment would render the corporation insolvent. Mrs. Kufsky’s corporation was insolvent at the time that it paid dividends to her, and, according to Mrs. Kufsky, subsection 38(3) therefore invalidated those dividends. The Tax Court disagreed. The court explained that, by issuing a dividend in contravention of subsection 38(3), a corporation and its directors face various penalties under Ontario’s Business Corporations Act, but subsection 38(3) doesn’t undo the very existence of a contravening dividend.
Finally, Mrs. Kufsky argued that a portion of the dividends were in fact loan repayments. This argument failed because of a long-entrenched tax-law principle: tax treatment flows from what a taxpayer actually did, not from what a taxpayer, in retrospect, would have done. The court observed that, despite what Mrs. Kufsky now sought to call the payments, she and the corporation had reported those payments as dividends. The court rejected Mrs. Kufsky’s attempt at recharacterizing the payment. It reasoned that “[b]y reporting the relevant amounts as dividends and receiving the potentially better tax treatment of a dividend, Ms. Kufsky cannot now succeed in claiming that those payments were salary or loan repayments for the purposes of a section 160 assessment.”
In the end, the court dismissed Mrs. Kufsky’s appeal and upheld her $68,615.69 derivative-tax assessment.
Pro Tax Tips: Avoiding & Responding to Derivative Tax Assessments under Section 160 of the Income Tax Act & Section 325 of the Excise Tax Act
If you receive dividends from corporation with outstanding income-tax debts or GST/HST debts, you’re exposed to derivative-tax liability under section 160 of the Income Tax Act or section 325 of the Excise Tax Act. There are several common strategies for challenging a derivative-tax assessment under section 160 or section 325. For example, you might challenge whether the corporation owed tax at the time it paid the dividend. But the Kufsky case illustrates that you won’t find relief by arguing that you provided consideration for the dividend or by attempting to recharacterize the payment retroactively. Your response will succeed only if it aligns with the governing legal principles and finds support in the available evidence. Consult one of our expert Canadian tax lawyers for advice on reducing your exposure to a derivative-tax assessment under section 160 of Canada’s Income Tax Act or section 325 of Canada’s Excise Tax Act.
To challenge a notice of assessment under section 160 of the Income Tax Act or under section 325 of the Excise Tax Act, you must file a notice of objection within 90 days from the date on the derivative-tax assessment. If you fail to meet the 90-day deadline, you might qualify for an extension, but you must apply for the extension within one year and 90 days from the date on the assessment or confirmation.
A notice of objection prompts the CRA’s administrative dispute-resolution process, and the Canada Revenue Agency’s Appeals Division will assign an appeals officer to review the merits of your objection. In the alternative, you may effectively bypass the CRA’s Appeals Division and appeal directly to Tax Court if the Appeals Division hasn’t rendered a decision within 90 days from the date that you filed your objection.
If the CRA’s appeals officer renders an unfavourable decision, you may continue the dispute by filing a notice of appeal to the Tax Court of Canada. You must appeal to the Tax Court of Canada within 90 days from the date on the notice of confirmation from the CRA’s Appeals Division. You may apply for an extension of time if you miss the 90-day deadline, but it is far harder to obtain an extension from the Tax Court of Canada (than from the CRA’s Appeals Division at the objection stage).
If you don’t exercise your objection or appeal rights within the statutory deadlines, you’ll be personally stuck with the derivative-tax debt—even if the original tax debtor discharges the debt under bankruptcy.
Fortunately, Canadian taxpayers can typically avoid these problems through early engagement of an experienced Canadian tax-litigation lawyer. Speak to our Certified Specialist in Taxation Canadian tax lawyer today. Our experienced Canadian tax lawyers thoroughly understand this area of law, and we can ensure that you deliver a forceful, thorough, and cogent objection to the Canada Revenue Agency or appeal to the Tax Court of Canada.
Frequently Asked Questions
Question: I own a corporation that owes a large income-tax debt to the Canada Revenue Agency. I understand that, under Canadian tax law, a corporation and its shareholder are two distinct taxpayers. So, to protect the corporate assets from CRA tax collectors, I plan on paying all the corporation’s cash to myself as a dividend. This shouldn’t pose a problem, correct?
Answer: You’ll expose your yourself to derivative tax liability under section 160 of Canada’s Income Tax Act. Section 160 is a tax collection tool, and it aims to thwart taxpayers who try to keep assets away from the Canada Revenue Agency by transferring those assets to related parties—such as shareholders. If your corporation pays all its cash to you as a dividend, section 160 allows the CRA’s tax collectors to pursue you for your corporation’s income-tax debts. Your derivative tax liability under section 160 is capped at the amount of the dividend (assuming that the dividend is less than the corporation’s income-tax debt).
Question: I recently received a notice of assessment for derivative tax liability under section 160 of the Income Tax Act. The assessment relates to cryptocurrency, non-fungible tokens, and other blockchain-based assets that I received from my corporation, which operates a cryptocurrency-trading business. I want to dispute this assessment. What should I do now?
Answer: You must file a notice of objection with the Canada Revenue Agency’s Chief of Appeals (Appeals Division). The objection itself must be filed within 90 days of the date on the section 160 assessment. A notice of objection prompts the CRA’s administrative dispute-resolution process, and the Canada Revenue Agency’s Appeals Division will assign an appeals officer to review the merits of your objection. In the alternative, you may effectively bypass the CRA’s Appeals Division and appeal directly to Tax Court if the Appeals Division hasn’t rendered a decision within 90 days from the date that you filed your objection. In either case, your response will succeed only if it aligns with the governing legal principles and finds support in the available evidence. Our experienced Canadian tax lawyers thoroughly understand this area of law, and we can ensure that you deliver a forceful, thorough, and cogent objection to the Canada Revenue Agency or appeal to the Tax Court of Canada.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."