Guidance on Arbitrary Tax Assessments and Derivative Tax Liability

What is an Arbitrary Tax Assessment?

When a taxpayer fails to file a tax return by the prescribed filing deadline, the Canada Revenue Agency may issue a tax assessment known as an “arbitrary” or “notional” tax assessment. These assessments are an estimate of what the Canada Revenue Agency computes the taxpayer should have reported on the unfiled tax return. The Canada Revenue Agency typically uses previous years’ tax filings and other information they have on record for the taxpayer to determine the appropriate tax assessment.  However, there is no legal requirement that the Canada Revenue Agency have a basis for arbitrary tax assessments. Most arbitrary tax assessments will result in higher taxes than if the taxpayer had filed the required tax returns.

Once an arbitrary tax assessment is issued, it is treated identically to an assessment resulting from a taxpayer filing a tax return. The amount of tax assessed is considered legally owed to the Canada Revenue Agency. The Canada Revenue Agency may use various enforcement measures to collect the outstanding tax balance, including seizing assets including bank accounts and issuing derivative tax assessments. Two potential derivative tax assessment types are assessments under section 160 of the Income Tax Act when a taxpayer transfers assets for less than fair market value and Director’s Liability assessments under section 227.1 of the Income Tax Act and section 323 of the Excise Tax Act.

The Assessed Taxpayer Disputing an Arbitrary Tax Assessment

The expert Toronto tax lawyer for a taxpayer can dispute an arbitrary tax assessment in two ways.

• File a Notice of Objection within 90 days of the assessment being issued, or within 90 days plus a year with an approved extension of time request;or
• File a tax return for the year (often known as “filing over”).

The taxpayer may be required to provide supporting documentation with the tax return. Generally speaking, the Notice of Objection is the better way to object to these tax assessments as it guarantees a review of the issued tax assessment. With income tax assessments, filing a Notice of Objection also suspends legal collections action until the objection is resolved. That is not the case with GST/HST assessments.

The Canada Revenue Agency is not required to reassess a taxpayer, even where the tax assessment was an arbitrary assessment and not based on the taxpayer’s own reporting. As such, a taxpayer’s best bet will always be filing their tax return on time and avoiding an arbitrary tax assessment.

Section 160 Assessment: Derivative Tax Assessment Caused by Transferring Assets

Section 160 of the Income Tax Act was enacted to discourage taxpayers from transferring their assets to other persons to prevent the taxpayers’ assets from being seized by the Canada Revenue Agency’s Collections Department in lieu of unremitted taxes. A Section 160 tax assessment arises where a taxpayer who owes taxes to the Canada Revenue Agency transfers an asset to another person (the “gift recipient”) for less than fair market value consideration. These tax assessments are derivative assessments meaning the gift recipient, not the taxpayer, will be assessed under Section 160. The value of the assessment will be the lesser of

• The taxpayer’s unpaid taxes
• The difference between the fair market value of the asset gifted or transferred and the value of any consideration received by the taxpayer from the asset recipient for the asset.

Using Section 160 assessments, the Canada Revenue Agency can collect arbitrarily assessed tax from other persons. Section 160 assessments can apply to corporations and individual taxpayers.

Section 323 and Section 227.1 Assessments: Director’s Liability

A director and a corporation are considered legally separate people, but in some cases the Canada Revenue Agency can “pierce the corporate veil” and hold the director responsible for the corporation’s actions. Director’s tax liability assessments are one of these cases. When the corporation fails to remit GST/HST or payroll taxes, the Canada Revenue Agency can assess the corporation’s directors for the unremitted taxes. For payroll, these assessments are made under section 227.1 of the Income Tax Act. A payroll director’s liability assessment may also include unremitted CPP under subsection 21.1(1) of the Canada Pension Plan Act, unremitted EI under subsection 83(2) of the Employment Insurance Act and unremitted provincial payroll taxes under the relevant section of the applicable provincial act. For GST/HST, director’s liability assessments are made under section 323 of the Excise Tax Act. Director’s tax liability renders the directors “joint and severally” liable, meaning each director is individually liable for the entirety of the corporation’s unremitted taxes. A director cannot be assessed for the corporation’s unpaid taxes where he or she acted duly diligently or ceased being a director of the corporation legally and factually more than two years prior to the date of derivative tax assessment.

Pro Tax Tips: Derivative Tax Assessed Taxpayer Challenging the Arbitrary Tax Assessment

Taxpayers who are assessed tax liability on a derivative basis related to an arbitrary tax assessment of a third party have two ways to dispute the derivative tax assessment.  Firstly, they can argue they were improperly arbitrarily assessed. For example, a director may claim he or she ceased being director prior to the assessment period or a person under assessed under section 160 may claim consideration equal to the fair market value of the asset was provided. Alternatively, the taxpayer can challenge the underlying arbitrary assessment. In Barry v. The Queen, 2009 TCC 508, the court found a director can challenge the underlying assessment even where the corporation did not challenge the original tax assessment. Taxpayers who are derivatively assessed in relation to an arbitrary assessment should contact our expert Toronto tax lawyers to discuss the best strategy to challenge the tax assessment(s).

About the Author

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David J. Rotfleisch

David J. Rotfleisch, a leading Canadian tax lawyer, is not only a certified specialist in taxation but also a chartered professional accountant. Most recently, David is a pioneer in Canadian crypto taxation.

As of April 2020, he was one of 12 Ontario Certified Specialists In Taxation™.

Learn more about David J. Rotfleisch