Valid Consideration Under Enforceable Oral Contract – Canadian Tax Case Analysis

Brown v The Queen – Subsection 160(1) Valid Consideration Under an Enforceable Oral Contract – Canadian Tax Lawyer Analysis

Introduction –Anti-Avoidance Rule in Subsections 160(1) of the Income Tax Act

Canada’s federal Income Tax Act contains anti-avoidance provisions that are designed to protect the collection of taxes by the Minister of National Revenue (the “Minister”). One of these provisions is subsection 160(1). Where a tax debtor transfers property to a related person in order to escape his or her tax liability, subsection 160(1) of the Income Tax Act renders the other person (the property transferee) liable for the tax debt of the transferor.

In Brown v The Queen, the main issue before the Tax Court was whether the taxpayer was liable for tax in respect of funds transferred to her by her spouse, Mr. Gordon Levoy, at a time when her spouse owed a tax debt to the Minister. In this case, the Tax Court held that subsection 160(1) of the Income Tax Act did not apply since the taxpayer gave valid consideration of equal value for the funds deposited into her personal bank account by her spouse, in accordance with the terms of the enforceable contract between the taxpayer and her spouse.

Brown v The Queen – The Facts

Taxpayer’s spouse was the only shareholder and director of Georgian Manor Resort in Collingwood, Ontario that rented out a call centre as part of its operations. In 2002, criminal charges were laid against the taxpayer’s spouse as a result of criminal activities that were perpetuated by persons renting out the call center. After the criminal charges were laid, the taxpayer’s spouse submitted a voluntary disclosure to the Canada Revenue Agency (CRA) for taxes owing in preceding taxation years. Although the voluntary disclosure application was denied, the taxpayer’s spouse was reassessed for his taxes owing from 1997 through 2007 taxation years. Although the criminal charges against the taxpayer’s spouse were eventually withdrawn, he was unable to access his bank accounts, which were automatically closed when the criminal charges were initially laid against him. As a result, between 2006 and 2008 the taxpayer and her spouse entered into an oral arrangement wherein the spouse’s bi-weekly salary cheque from Georgian Manor Resort was deposited into the taxpayer’s bank account and used by the taxpayer to pay her spouse’s credit card bills. When the deposits exceeded the credit card bills, the taxpayer used the excess funds to make subsequent payments on her spouse’s credit card bills. In addition, between 2007 and 2008 the taxpayer used $30,000 of her personal funds to cover her spouse’s credit card bills. At no point in time did the spouse have access to the taxpayer’s bank account nor was he provided with the taxpayer’s bank account statement. As well, at no point in time did the taxpayer have control or discretion with respect to the funds deposited into her account by her spouse. The CRA reassessed the taxpayer’s 2006 through 2008 taxation years pursuant to section 160 of the Income Tax Act on the basis that the taxpayer was liable for tax on the funds transferred to her by her spouse at a time when her spouse owed a tax debt.

Brown v The Queen – The Issues

• Whether section 160 of the Income Tax Act applies to funds transferred to the taxpayer by her spouse, during the 2006, 2007 and 2008 taxation years.
• Particularly, did the taxpayer give adequate consideration pursuant to paragraph 160(1)(e) of the Income Tax Act?
• Further, does the successful completion of the bankruptcy proposal by the taxpayer’s spouse (the property “transferor”) have the effect of extinguishing the debt of the taxpayer (the property “transferee”)?

Brown v The Queen – The Position of the Parties

The Canadian tax lawyer for the taxpayer argued that a section 160 liability did not apply since valid consideration of equal value was exchanged for the funds transferred. The taxpayer explained that valid consideration of equal value existed in that the funds transferred were used to make payments on her spouse’s credit card bills. The taxpayer also argued that the sole intention of making such arrangement with her spouse was to provide a way for the spouse to deposit his salary and use the funds to pay credit card bills, since he was unable to open a bank account in his own name at the time the arrangement was made. To illustrate, the taxpayer and her spouse were not trying to thwart the CRA’s collection efforts and the arrangement was made between the taxpayer and her spouse when he (taxpayer’s spouse) had not yet been assessed by the Minister. Further, the taxpayer argued that CRA conceded to her obligation under the arrangement between her and her spouse, being the legal obligation to pay her spouse’s credit card bills with the funds deposited into her account.
In contrast, the CRA relied on the Federal Court Appeals decisions in Raphael v R and Livingston v R as well as the Tax Court decision in Pickard v R in arguing that subsection 160 of the Income Tax Act did not apply since there was no consideration given by the taxpayer to her spouse in exchange for the funds deposited into her account. The CRA argued that there was no link between the funds deposited and the credit card bills paid by the taxpayer. In addition, the CRA relied on evidence that the taxpayer paid $30,000 of her personal funds to cover her spouse’s outstanding credit card bills to argue that she (the taxpayer) had a moral obligation to assist her spouse. Further, the CRA argued that the taxpayer was a supplementary holder of two of her spouse’s credit cards and that she (the taxpayer) benefited from the use of one of these two cards. Moreover, the CRA argued that incomplete evidence with respect to the credit card statements filed by the taxpayer are sufficient for the Tax Court to conclude that the taxpayer had not clearly established that all the expenses paid by her were in fact the personal expenses of her spouse.

Brown v The Queen – Tax Analysis

The Tax Court rejected the taxpayer’s argument that the CRA conceded to her legal obligation and confirmed that the CRA’s concern pertains to a moral obligation (as opposed to a legal obligation). The Tax Court held that determining whether a legal obligation existed is a question of both facts and the law.

The Tax Court referred to Livingston v R, wherein the Federal Court of Appeal set out the four key criteria to determining if section 160 of the Income Tax Act applies:

• The transferor must be liable to pay tax under the Act at the time of transfer;
• There must be a transfer of property, either directly or indirectly, by means of a trust or by any other means whatever;
• The transferee must either be:
  • The transferor’s spouse or common-law partner at the time of transfer or a person who has since become the person’s spouse or common-law partner;
  • A person who was under 18 years of age at the time of transfer; or
  • A person with whom the transferor was not dealing at arm’s length.
• The fair market value of the property transferred must exceed the fair market value of the consideration given by the transferee.

Since the taxpayer admitted that the first three requirements under the Livingston v R test were met, the sole issue before the Tax Court was the fourth requirement, whether the taxpayer gave fair market value consideration in exchange for the property transferred to her by her spouse.

In light of the circumstances in this case, the Tax Court held that the Federal Court Appeal’s findings in Raphael v R supports the taxpayer in this case. Particularly, the Tax Court referred to the Federal Court of Appeal’s decision in Raphael v R which held that “if indeed the wife had made a legally enforceable promise to pay out the monies only on the husband’s direction to his creditors in amounts equal to the monies transferred this might well have constituted sufficient consideration equal in value to the property transferred, then section 160(1) does not apply”.

In this case, the Tax Court held that an enforceable contract did exist between the taxpayer and her spouse. The contract being that the taxpayer undertook to deposit her spouse’s paycheque into her personal bank account and in return she committed to pay his credit card bills pursuant to his direction. In addition, the fact that the taxpayer’s spouse could have taken legal action against the taxpayer to enforce the agreement was sufficient evidence that she (the taxpayer) could have been forced to pay her spouse’s credit card bill even if she has refused to pay.

The Tax Court held that, contrary to Livingston v R, in this case there are no supporting evidence that there was an intention to defraud the CRA. Unlike Livingston v R, in this case the tax debtor (being the taxpayer’s spouse) did not have access to the bank account or bank accounts statements belonging to the taxpayer. The Tax Court explained that the taxpayer did not benefit from the transfer of her spouse’s funds into her personal bank account because of her commitment to pay his credit card bills, which she did. For these reasons, the Tax Court held that there was consideration given by the taxpayer to her spouse in exchange of the funds transferred.
Further, the Tax Court distinguished its own decision in Pickard v R on its facts and its difficulty to establish whether there was a consideration due to insufficient evidence. The Tax Court explained that, unlike the taxpayer in Pickard v R, the taxpayer in this case never used the funds deposited by her spouse into her personal bank account to pay for her own personal expenses. Unlike the facts in Pickard v R, the taxpayer in this case maintained detailed records of the funds that belonged to her spouse, namely the funds deposited, as well as the monthly credit card payments she made on his behalf. Moreover, the Tax Court held that “not only the documents were more than sufficient, but they also corroborated the testimonies of the Appellant” and her spouse.
The Tax Court also rejected the CRA’s position that there was no link between the funds deposited and the credit card bills paid by the taxpayer on the ground where there were an excess at the end of a year, the taxpayer would use the excess to pay the next year’s credit card statements. The Tax Court explained that the taxpayer used all the money deposited by her spouse into her personal bank account, as well as $30,000 of her own funds, to pay his credit cards bills.
The Tax Court also rejected the CRA’s argument that the taxpayer had a moral obligation to assist her spouse by the fact the she used $30,000 of her own funds to pay off her spouse’s credit card bills. The Tax Court explained, the taxpayer’s personal decision to use her own money to pay off her spouse’s credit card bills does not disregard her legal obligation under their arrangement to use the money deposited by her spouse to pay his credit card bills, which she did.

Moreover, the Tax Court held that the documentary evidence together with the oral testimonies of the taxpayer and her spouse were sufficient to establish that payments were made to pay the personal expenses of the taxpayer’s spouse. In addition, in the Partial Agreed Statement of Fact the Canadian tax lawyer for CRA conceded that the taxpayer paid her spouse’s credit card bills.

The Tax Court accepted the CRA’s argument that there was sufficient evidence revealing that the taxpayer was a supplementary cardholder with respect one of the credit cards belonging to her spouse. However, the Tax Court explained that the evidence also revealed that the taxpayer reimbursed the amounts she incurred on the relevant credit card since she (the taxpayer) used her own funds to pay her spouse’s credit card bills between the 2007 and 2008 taxation years, when he (taxpayer’s spouse) was incapable of working on a full-time basis.

In light of these circumstances, the Tax Court confirmed that the consideration in this Appeal is that the taxpayer committed to paying her spouse’s credit card bills, per her spouse’s instructions, with the funds he deposited into her personal account and the evidence confirmed that she did.

Brown v The Queen – The Holding

The Tax Court held that subsection 160(1) of the Income Tax Act did not apply in this appeal on the grounds that there was an enforceable contract between the taxpayer and her spouse and explained that there was valid consideration equal to the value of the property transferred. Further, the Tax Court decided that since subsection 160(1) of the Income Tax Act did not apply there was no need to analyze the effect of the bankruptcy proposal. The tax appeal was allowed with costs for the taxpayer.

Pro Tax Tips – Liability for Tax

Understanding the tax collection provisions under subsection 160(1) of the Income Tax Act and the CRA’s collection procedures, powers and limitations is crucial for taxpayers to meet their tax obligations proactively. If you have questions regarding enforceable contracts and consideration relating to the transfer of property between non-arm’s length parties, please contact our tax law office to speak with one of our experienced Certified Specialist in Taxation Canadian tax lawyers.

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