Published: March 12, 2020
Last Updated: April 26, 2021
Introduction – CRA Collections Powers
While generally speaking, Canada Revenue Agency (“CRA”) can only collect taxes owing from the taxpayer who owes the debt, there are several exceptions to this general rule. The Tax Act is concerned with the tax liability of each distinct “taxpayer”, a term that is defined to include persons and corporations, but which does not include households or family members. For this reason, Revenue Canada cannot initiate collections action against the wife or wealthy sibling of a debtor taxpayer, nor can the director of a corporation normally be held liable for the income tax debt of the business.
However the Canadian Tax Act does give CRA expansive powers that allow it to conduct “derivative” assessments against taxpayers who have some connection to, but who are not necessarily responsible for, a particular tax debt in certain specific legislated fact scenarios. The director of a corporation can be personally assessed by Revenue Canada for the GST/HST and Payroll Source Deduction liabilities of his or her corporation. Similarly, if an individual or corporate tax debtor transfers property or money to another taxpayer for less than full value, the person to whom the property was transferred can be held jointly and severally liable with the tax debtor for the amount of the debt. This joint liability is capped by the value of the property transferred and the amount by which the value of the property or money transferred exceeds any cash or property given back by the transferee. Essentially, the CRA cannot chase a third party for a debt that exceeds the value of property transferred to that third party.
This article will look at the ability of CRA to issue these derivative assessments and some of the defences that are available to parties who are assessed personally for the debts of a different taxpayer.
Director’s Liability Assessments
Corporations that are required to collect GST/HST and Payroll Source Deductions do so behalf of the Canadian government and have a statutory duty to remit these funds to Revenue Canada. Quite simply, the funds do not belong to the corporation collecting them and they never did. They are considered to be tax trust funds. Under subsection 227.1(1) of the Income Tax Act, the director of a corporation that fails to remit Payroll Source Deductions to CRA is jointly and severally liable with the corporation for the unremitted Payroll Source Deduction. Subsection 323(1) of the Excise Tax Act, contains an almost identical provision which makes directors jointly and severally liable with their corporations for the corporation’s failure to properly collect and remit GST/HST to Revenue Canada.
These “Director’s Liability Assessments” can have disastrous effects on the personal lives of directors: even a relatively small business can have annual GST/HST and Payroll Source Deduction liabilities in the tens of thousands of dollars.
Directors who are assessed personally for the GST/HST and/or Payroll Source Deduction liabilities of their corporation should speak to one of our leading Tax Litigation Lawyers to determine if they have any defences available, which are discussed in more detail below.
Defences to Director’s Liability Assessments
Taxpayers who find themselves the recipient of a Director’s Liability assessment under either or both of Tax Act and Excise Tax Act are not without options: there are several defences to these assessments, some of which are discussed below.
Two-Year Limitation Period for Director Liability
Subsections 227.1(4) of the Income Tax Act and 323(5) of the Excise Tax Act create identical statutory limitation periods within which Revenue Canada must assess the director: no valid assessment can be issued against the director of a corporation for the GST/HST and/or Payroll Source Deduction liabilities of his or her corporation “more than two years after the director last ceased to be a director” of that corporation.
In Butterfield v Canada, 2010 FCA 330, the Federal Court of Appeal reiterated the well- established principle that in order to be entitled to the two-year limitation period defence, the former director must have legally ceased to be a director more than two years before the director’s liability assessment was issued. In Butterfield, the former director taxpayer argued that due to the corporation making an assignment in bankruptcy, he was prevented by the trustees in bankruptcy from “performing the functions of a director” and thus ceased to be a director on the date the corporation made an assignment in bankruptcy. The Court in Butterfield dismissed the taxpayer’s argument and instead focused on the fact that the taxpayer “never tendered his resignation and remained a director until the company was struck from the British Columbia Corporate and Personal Property Registries… this was then the date on which the appellant last ceased to be a director”. The Butterfield case is also authority for the proposition that the two year limitation clock starts running once a corporation is dissolved: one cannot be the director of a corporation that does not exist.
Challenge the Underlying Assessment
In Barry v The Queen, 2009 TCC 508, the Tax Court of Canada ruled that a director assessed for the GST/HST and Source Deduction liabilities of a corporation is able to raise any defences and/or challenges to the underlying corporate assessment, even if the corporation chose not to do so. In Barry, the taxpayer brought a motion to bring in evidence, and have the Minister answer questions, relating to the assessment issued against the corporation for which the taxpayer director was being held liable. The Minister had refused to comply with the requests because they were “clearly irrelevant”, because the taxpayer “cannot challenge the correctness of the underlying corporate assessments”. In siding with the taxpayer, the Court in Barry observed that “to bind any taxpayer, including a director, to an assessment issued to another taxpayer violates rules of natural justice”. The logic of the Court in Barry is sound: regardless of any connection between a corporation and its director(s), they are still considered separate taxpayers under the Tax Act, and one cannot be bound by the outcome of a separate proceeding involving the other.
Due Diligence Defence to Director Liability Assessments
There is also a “due diligence” defence available to taxpayers who are assessed for director’s liability by Revenue Canada. Subsections 227.1(3) of the Income Tax Act and 323(3) of the Excise Tax Act contain identical wording which states that a director is not liable for a corporation’s failure to collect GST/HST or Payroll Source Deductions if they “exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances”.
In Canada v Buckingham, 2011 FCA 142, The Federal Court of Appeal confirmed that the applicable standard with which to evaluate the “due diligence” of a director is the same under the Tax Act and the Excise Tax Act. The standard of review to be applied to the actions of a director in a director’s liability assessments was discussed by the Supreme Court of Canada in Peoples Department Stores Inc v Wise, 2004 SCC 68, where the Supreme Court held that an objective standard of reasonableness is to be used to evaluate the actions of a director assessed for the GST/HST and Source Deduction liabilities of his or her corporation.
According to the Supreme Court in Peoples, the director need only make “reasonable business decisions in light of all the circumstances about which the directors or officers knew or ought to have known”.
Further, the Federal Court of Appeal in Smith v Canada, 2001 FCA 84, emphasized that the standard is reasonableness, not perfection. In Smith, a retired teacher joined the board of directors of a company that was experiencing financial difficulties. Due to his limited experience in tax and business affairs, the Court in Smith held that the taxpayer had established due diligence by expending “considerable effort in trying to ascertain the amount of the corporation’s liabilities” and in how he went to “great lengths to attempt to ensure that the grant would be applied against the corporation’s obligations”. The case law, in addition to the presence of the due diligence defence in the Income Tax and Excise Tax Acts, makes it clear that a director is not defenceless against an assessment simply because the corporation accumulates GST/HST and Source Deduction arrears.
Non-Arm’s Length Transfers to Third Parties at Below Fair Market Value
Tax debtors cannot frustrate the attempts of Revenue Canada to collect on taxes owing simply by transferring their assets to their spouses or other close acquaintances for less than fair market value. Section 160 of the Income Tax Act give CRA the ability to attack such “non-arm’s length” transactions by making the transferee jointly and severally liable with the transferor for tax debts of the transferor incurred either prior to, or during, the taxation year in which the property was transferred. The maximum amount that the transferee is liable for under a section 160 assessment is the lower of:
- The amount by which the fair market value of the property transferred exceeds the fair market value of the consideration given for the property;
- The total of all amounts that the transferor tax debtor is liable to pay under the Tax Act in respect of the taxation year in which the property was transferred or any preceding taxation year.
For example, if a tax debtor has a tax debt of $25,000 and transfers a vacant lot valued at $100,000 to her husband for $10,000, the most the transferee husband can be assessed for is $25,000 because $25,000 is less than the amount of “free land” that the husband received, which would have a value of $90,000 ($100,000-$10,000) if the estimated value of the vacant lot is accurate. Note that this liability exists even if the tax assessment arises in a year subsequent to the transfer, if it relates to the tax year of the transfer or a previous year. So if the wife in this case had a tax liability of $25,000 for 2014 at the time of the transfer and was subsequently reassessed for $90,000 in respect of 2012, then the husband would have a tax liability to CRA for the entire value of the vacant lot transferred to him.
The courts have consistently given a broad interpretation to the term “transfer” in section 160, further enhancing the ability of Revenue Canada to collect tax debts from third-parties. In Hennig v R, 2012 TCC 141, the Tax Court of Canada held that a dividend issued by a tax debtor corporation to a shareholder with whom it did not deal at arm’s length was a transfer within the meaning of section 160 of the Tax Act, and that therefore an assessment issued against the transferee shareholder was valid. The Court in Hennig also confirmed that there is no time limit in which the Minister has to issue an assessment under section 160. In David Goldberg v The Queen,  2 CTC 2592, three siblings were assessed under section 160 for school and summer camp fees paid by their family trust, which owed taxes to CRA. Despite the fact that the funds were not transferred to any of the siblings directly, the Tax Court of Canada in Goldberg dismissed the appeals, concluding that the “money paid was transferred indirectly to the Appellants. It reached the Appellants in the form of the services which were rendered to the Appellants by the school and camp as consideration for the money paid”. The Goldberg case shows that the Minister is not at all shy about assessing third-parties for the tax debt of another, even if the transfer is for activities considered desirable by society, such as education or recreational activities.
In Wannan v Canada, 2003 FCA 423, the Federal Court of Appeal ruled that the parties exchanging the property in the non arm’s length transaction do not need to know about the tax debt in order to be liable under section 160. This is self-evident from the wording of section 160 of the Tax Act, which makes no mention of any intention to defeat creditors in its wording. Further, section 160 attaches liability to a transferee of property for the tax liability incurred in the year in which the property is transferred: the tax debt does not need to exist at the time of transfer; it only has to arise during the year of transfer. The Court in Wannan attributed an absolute liability interpretation to section 160 of the Income Tax Act, meaning that there is no due diligence defence available to the party who is assessed. While this no doubt appears harsh, it is important to remember that the most CRA can assess for under section 160 is the value that the transferee receives that is in excess of the consideration the transferee gave for the property, ie. the value that the transferee was given for free.
Defences to a Section 160 Assessment
A taxpayer who is assessed under section 160 of the Income Tax Act can have a tax lawyer file a Notice of Objection to the assessment just as is the case in any assessment under the Tax Act. While there is no due diligence defence to an assessment made under section 160, taxpayers can challenge the underlying assessment originally made against the transferor, in addition to bringing evidence forward to contradict the evidence relied upon by Revenue Canada.
Challenge the Underlying Assessment
In Gaucher v Canada,  1 CTC 125, the Federal Court of Appeal held that a taxpayer assessed under section 160 was allowed to challenge the underlying assessment against the transferor, even if the transferor has not done so. In Gaucher, the taxpayer argued that the Minister failed to reassess the transferor, her husband, within the normal reassessment period of three years, and that therefore the underlying assessment on which the section 160 assessment was based upon was invalid. In his decision, Rothstein JA stated that “the second person must have a full right of defence to challenge the assessment made against her, including an attack on the primary assessment on which the second person’s assessment is based”. The decision in Gaucher somewhat eases the harsh nature of section 160 of the Tax Act, realizing that the principles of natural justice require that a taxpayer assessed under the provision be able to raise any defence that would be available to the party who was originally assessed.
Attack the Minister’s Valuation of the Property Transferred
The basis of an assessment under section 160 is that Revenue Canada is alleging that the transfer was a non-arm’s length transaction for less than fair market value: if the transferee paid fair market value for the property transferred, there is no basis on which the Minister can assess. Similarly, if the Minister’s valuation of the property transferred can be challenged, this can reduce, or possibly eliminate any amounts owing as a result of the assessment. In Bjornson v The Queen, 2010 TCC 337, the Tax Court of Canada set aside a section 160 assessment because the value attributed to the transferred property by the Minister was much too high. In Bjornson, a tax debtor husband transferred a van to his wife when he had a tax debt of $27,000. The Minister valued the van at $43,000 and, recognizing that there was approximately $23,000 owing on the van, determined that the equity in the van at the time of transfer was roughly $20,000 and decided to issue an assessment to the tax debtor’s wife for that amount under section 160. The Court in Bjornson accepted the evidence of an independent automobile appraiser, who valued the vehicle at $21,000, and concluded that there was no equity in the van, due to the $23,000 owing on the van, and the assessment was therefore invalid. CRA can be very aggressive in its valuations of property and one of the more direct ways to oppose a section 160 assessment is for the taxpayer to show evidence that the Minister overstated the value of the transferred property.
Prove Value Was Given For the Money or Property Transferred
Section 160 does not apply to a situation where full consideration is given for the money or property transferred: a taxpayer can refute the assessment by providing evidence that they gave full value for the transfer. In Ducharme v Canada, 2005 FCA 137, a common-law spouse was assessed for the payments her common-law partner had made on a mortgage she owned. The Federal Court of Appeal in Ducharme concluded that section 160 of the Tax Act was inapplicable in this instance because the mortgage payments were made in lieu of paying rent, and such payments were far below market rates for rent in the area. Accordingly, the value that the tax debtor transferred, the mortgage payments, did not exceed the consideration he received for them, ie. having a place to live, rent-free. The key to section 160 being applied by Revenue Canada is that the property or money must be transferred without adequate consideration. Taxpayers can rebut the Minister’s position by providing evidence that the transfer took place at fair value.
Assert That No Transfer Took Place
Another way in which the Canadian tax lawyer of a taxpayer assessed under section 160 can challenge the assessment is by showing evidence that a transfer never took place. In Biderman v Canada,  2 CTC 35, a debtor taxpayer inherited property under his deceased spouse’s Will, and subsequently disclaimed any interest he was entitled to as a beneficiary under the Will, with the result being property transferred to other members of his family in lieu of the tax debtor. The Minister sought to collect the debts of the tax debtor from these “subsequent beneficiaries”. In Biderman, even though the Federal Court of Appeal eventually ruled that the Taxpayer’s disclaimer was invalid, the Court opined that if a valid disclaimer had in fact been given, then a transfer within the meaning of section 160 of the Income Tax Act would not have occurred and the subsequent beneficiaries would not be liable for an assessment under section 160. The rationale is simple: by disclaiming interest in a testamentary gift, the disclaiming party never acquires an interest in the gifted property and therefore cannot be said to have transferred the property.
Our Toronto tax lawyer firm was retained by Rosanne, who lives in Bolton, who had been assessed by Revenue Canada under section 160 of the Tax Act for over $140,000. She was referred by a trustee in bankruptcy in order to attempt to avoid making a bankruptcy assignment. Her husband, who owed taxes to the Canadian government, had deposited cheques into her bank account over a number of years and CRA alleged that she had received the $140,000 for no consideration. Our Canadian Tax Lawyers were able to work with Rosanne to provide CRA with evidence from her bank that showed that the amounts her husband had given her were payments for his fair share of the mortgage on their home. After considering our submissions, CRA overturned the prior reassessment in its entirety.
Keith from Brampton retained our Canadian tax litigation lawyers after he received a director’s liability assessment for $194,855.26 from Revenue Canada for the payroll source deduction arrears of his corporation. We filed a Notice of Objection on his behalf, providing evidence that he ceased to be a director of the corporation more than two years prior to the director’s liability assessment being issued. CRA accepted our submissions and allowed the Notice of Objection in full, completely reversing the assessment issued against Keith.
Derivative assessments are an exception to the general rule that taxpayers are only responsible for their own tax debts. Both director’s liability and section 160 assessments can have potentially devastating effects on the lives of taxpayers who are assessed, but there are defences available to each assessment. Further, Revenue Canada will often issue a “proposed assessment” to a taxpayer before the actual reassessment is issued. The key is to be proactive in acquiring the services of one of our experienced Canadian Tax Litigation Lawyers to help manage the process and scrutinize the assessments. If CRA has only issued a “proposed assessment”, our Toronto tax lawyers can help fight CRA and in some cases prevent the assessment from ever being issued. If the assessment has already been issued, then our legal tax firm can correspond with CRA on the taxpayer’s behalf, help to prevent collection action and assist the taxpayer with the compilation of evidence and legal submissions necessary to fight the assessment.
"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."