Introduction: CRA Debts Can Lead to Family Breakdown
As we've mentioned before in our articles, as experienced Canadian tax lawyers we practice a very specialized area of law in which we have developed a specific and valuable set of skills. At the same time because tax affects so much of Canadians' everyday lives, even if they don't realize it, we necessarily need to develop an understanding of other areas of law. One of the ways in which our tax knowledge can come in handy is when a marriage or other spousal relationship becomes strained due to financial hardship, including Canada Revenue Agency debts.
As family lawyers well know, it is not uncommon that when you ask a person why their spousal relationship broke down, that money problems is one of the key factors. Indeed and unfortunately many taxpayers that reach out to our Canadian tax Law firm for help often do so because of large tax debts to the CRA, debts that seem insurmountable without proper advice and tax guidance.
Tax Debts Are Often Not Eliminated Completely
Although as Canadian tax lawyers our main goal is always to review a client's situation, provide advice and dispute improper CRA assessment or reassessment action, at a certain point in the tax review process eventually the amounts will be determined and the CRA tax collections department will start to aggressively collect taxes owing. Indeed, while CRA does often get things wrong when it performs a tax audit, it is often the case that even when eliminating improper calculations that some, if not a significant amount, of tax debt remains.
The most common scenario we come across is a spouse who is engaged in business for themselves either as a sole proprietor or through a corporation who ends up with a large legitimate tax debt. The common, understandable and wrong reaction to this by many taxpayers is to attempt to protect the assets that they have built up by transferring them to their spouse. While this strategy can work to stall collections, it actually makes the problem worse by creating a situation where the CRA can now take legal action against the recipient spouse to collect amounts owing by the tax debtor utilizing cash or property owned by the recipient spouse.
The Derivative or "Memo" Assessment
As we have detailed in some of our other articles, the CRA has broad collections powers when it wants to enforce the repayment of a tax debt. It can take legal action without notice to the taxpayer to seize and sell property, garnish bank accounts, lien houses and much more, all without judicial authorization being required. CRA, unlike other debtors, can assess an amount as owing and then take collection action to enforce that assessment. If the reaction to this is for the spouse with the tax debt to panic or scheme and attempt to transfer assets to their significant other they are passing along the problem not unlike a Covid transmission.
In this case, the CRA has tax collection powers under both the Income Tax Act and the Excise Tax Act, sections 160 and 325 respectively, that allow them to assess a non-arm's length third-party (such as but not exclusively a spouse) for the tax debt of the transferor spouse upon receipt of property from that tax debtor for which they have not paid fair-market value. So in the most typical scenario, the transferring of title in a house, the transferee spouse will now owe taxes equivalent to the original debtor or the value of the property transferred, whichever is less. This type of tax assessment is called a "derivative" or "memo" assessment.
In the family law context, we have found that by the time that property is being transferred the debts have piled up for some time and the parties are usually separated or contemplating divorce (where applicable) due to the strain on the interpersonal relationship. Often, taxpayers contemplating this will attempt to transfer property as above to "save" it from the CRA while the divorce or separation is ongoing. Often, they will not even tell their family lawyer if they have one about this, thinking that such things are either unimportant or hoping they will be overlooked.
There Are Proper Family Law Exceptions to the Derivative Assessment
Fortunately, there are exceptions to the non-arm's length transfer rules, even if the unfortunate side is that the taxpayer and spouse must be preparing to actually sever their relationship with each other.
Sections 160 and 325 of the Income and Excise Tax Acts allow property to be transferred to a spouse for no consideration if done so in the context of a proper separation or divorce agreement. The agreement must be in writing and agreed to by both parties in order for it to be effective. In addition, property ownership between spouses can be complex, and so it is important that the language and description of any property being transferred as a part of the overall process be fine tuned. Failure to property draft a divorce or separation agreement could be the difference between protecting assets from the CRA for future generations and losing the ability to keep them from the CRA's collectors.
It should also be kept in mind that the transfers must have actually have taken place concurrently or subsequent to any separation or divorce agreement being put in place. For example, if the husband transfers his half of title in the family home to the wife to stall collections, but then later enters into a divorce agreement, the protection will not be effective as the transfer could not have been made according to the agreement itself. Proper tax planning guidance is required from the beginning in these scenarios, as there is a limit to what Canadian tax lawyers can do to correct these types of mistakes.
Pro Tax Tips-Why Tax Guidance Can Help - Canadian Tax Lawyer's Analysis
As experienced Canadian tax lawyers, we have the ability to determine, from income tax point of view, what property spouses own that should be divided, and how. When this is done in support of a family lawyer, the division of assets and the negotiation around same can take on a new dimension when considering a proper plan for asset protection from the tax collector.
As a part of our tax guidance to clients we always emphasize that in tax law "form matters", meaning that properly structuring and characterizing any form of deal can be the difference between a high tax liability and reducing or sometimes eliminating it completely. This is no different in the family law context, though the emotional aspect may be more intense than a typical business deal.
If you are a taxpayer contemplating or going through a divorce, or a family lawyer who would like to maximize value for your client in their ongoing dispute, give our top Canadian tax lawyers a call. We can work in a support role to ensure that you are maximizing savings during this most costly of times. Those that seek out tax guidance in advance will be surprised at the tax savings our office can facilitate in the short or long term.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.