Subsection 160(1) of the Income Tax Act contains rules that may impose one taxpayer’s tax liabilities on another party, where they have transacted at less than fair market value. These rules provide that where a taxpayer transfers property to a non-arm’s length party (including relatives) for less than market value at a time that the transferor has a tax liability, the transferee will be jointly and severally liable for the transferor’s tax liability. The transferee’s liability under these rules would be limited to the amount by which the value of the transferred property exceeds the value of any consideration provided for the transfer (up to the amount of the transferor’s tax liability). These rules may also apply where the transferor’s tax liability is itself an indirect liability, such as where a director of a corporation is liable for a corporation’s unremitted payroll source deductions, for example. In addition to income tax liabilities, similar rules exist for GST/HST liabilities.
As an example, assume that Wife has a tax liability of $100,000 and sells property with a value of $50,000 to Husband for proceeds of $10,000. Husband would be jointly and severally liable for $40,000 of Wife’s tax liability, calculated as the value of the transferred property ($50,000), less the amount paid to Wife for the property ($10,000).
While it may seem reasonable that these rules would apply to the example outlined above, they may also apply to more innocuous transactions. For example, assume that Opco pays a dividend of $100,000 to its shareholder at a time that Opco has a tax liability of $250,000. Since the shareholder is not considered to have provided any consideration for the dividend (because dividends are paid in respect of ownership, and not in respect of services provided), the shareholder may be liable for up to $100,000 of Opco’s tax liability. The shareholder’s subsection 160(1) liability in this case would not even be reduced by the amount of personal tax he or she may incur in respect of the dividend income, potentially exacerbating the issue. The payment of a dividend to a corporation would also be caught by these rules.
Taxpayers should be cautious in transacting with related parties in the current environment, when some may still have outstanding tax liabilities as a result of the Covid pandemic. As we approach the end of the calendar year, many business owners will be considering their remuneration planning for the year, including whether to pay themselves and family members dividends or additional salary. Since salaries are generally considered to have been paid for consideration (i.e., for services provided), paying a reasonable salary in these situations may entail less risk than declaring a dividend.
The rules are broadly worded in a way that they may unexpectedly apply to many types of transactions. Please consult your Welch LLP advisor to help you navigate these potential issues.