In order to assist the Canadian government in the collection of tax, the Income Tax Act and Excise Tax Act (GST/HST) each contain provisions that allow the Canada Revenue Agency to assess third-parties for the tax debt of another taxpayer in certain circumstances through the use of what are collectively referred to as derivative assessments. Through section 160 of the Income Tax Act and section 325 of the Excise Tax Act, CRA is able to trace below fair market value transfers from a tax debtor to a non-arm's length transferee and thereby assess the transferee for the income tax debt or GST/HST debt of the original transferor tax debtor. In addition, the director(s) of a corporation can be held jointly and severally liable for the payroll source deduction and GST/HST arrears of their corporation.
Although there are specific defences set out in the Income Tax Act and Excise Tax Act with which a taxpayer assessed for the tax debt of another person can avail themselves, in some cases the most effective way to fight such tax assessments is to challenge the validity of the original underlying tax assessment issued to the original tax debtor by filing a tax Notice of Objection. This strategy is available even if the initial tax debtor did not themselves bother to challenge the tax assessment. Although the Canadian Income Tax Act and Excise Tax Act do not contain provisions that explicitly authorize challenging the underlying tax assessments, the Tax Court of Canada and Federal Court of Appeal have endorsed the legal principle that a taxpayer cannot be bound to the outcome of tax litigation to which it was not a party and, as a result, have consistently allowed taxpayers to challenge the underlying tax debt for which they have been issued tax assessments. If you have been assessed for the tax debt of another taxpayer, speak with one of our top Toronto tax lawyers to get a breakdown of any and all defences available to you and to file a Notice of Objection within the 90 day time period.
Transfers for Below fair-Market Value – Section 160 of the ITA and Section 325 of the ETA
Section 160 of the Income Tax Act and Section 325 of the Excise Tax Act are arguably the most powerful collection provisions available to CRA. A common application of each provision is when an income tax or GST/HST debtor transfers property to a family member for little or no consideration. To the extent the value of the property transferred, net of any mortgage or encumbrance, exceeds the consideration paid to the transferor tax debtor by the transferee, the transferee is liable for an amount equal to the lower of the tax debt and the "free property" received from the transferor tax debtor. For example, a taxpayer who owes $50,000 in income tax to Her Majesty might decide to transfer their half in the $500,000 matrimonial home to his or her spouse for no consideration. Assuming the home has a $250,000 mortgage, the value of property transferred to the spouse for no consideration would be $125,000. Since the $50,000 tax debt is less than the $125,000 value of the property transferred in excess of the consideration paid, the transferee spouse could be assessed under section 160 of the Tax Act for $50,000 to the extent CRA is unable to collect the tax debt from the transferor tax debtor.
Fighting the Underlying Tax Debt of the Transferor – Basic Rule of Natural Justice
In Gaucher v The Queen, 2000 DTC 6678, Ms. Gaucher was assessed under section 160 of the Income Tax Act as a result of the transfer of a residential property to her by her former spouse at a time when her former spouse had an income tax debt. Ms. Gaucher sought to have the reassessments originally issued to her former spouse declared as statute-barred and therefore invalid. The Tax Court of Canada rejected her argument since it had already affirmed the former spouse's reassessments. The Federal Court of Appeal over turned the Tax Court's decision, specifically due to the derivative nature of section 160. Rothstein JA stated that barring a statutory provision to the contrary, it is a "basic rule of natural justice" that a person who is not a party to litigation cannot be bound by the outcome of that litigation.
The Gaucher decision has been universally accepted in tax litigation and there is now no question as to the right of a taxpayer assessed under either section 160 of the Tax Act or section 325 of the Excise Tax Act to challenge the underlying tax debt of the transferor. This is of utmost importance because underlying assessments are often incorrect. When a taxpayer does not file tax returns when required by the Income Tax Act, CRA will often issue "arbitrary" assessments to the taxpayer under subsection 152(7) of the Tax Act. Arbitrary assessments are estimates of a taxpayer's liability, based on information that is available to Revenue Canada, and are almost always too high. In such a case, the party issued an assessment under section 160 or section 325 can often lower the tax assessment substantially by simply filing a proper tax return that correctly reflects the transferor's tax debt.
Director's Liability Assessments – Gaucher Principle Applies
By virtue of section 227.1 of the Income Tax Act and section 323 of the Excise Tax Act, the directors of a corporation can be held jointly and severally liable for the payroll source deduction and GST/HST arrears of their corporation. There need not be any misallocation of funds by the directors or alleged acts of negligence. Simply put, if you are the director of a corporation that accumulates source deductions and GST/HST arrears, CRA can and will assess you if the corporation cannot satisfy the debt.
In Wayne Barry v The Queen, 2009 TCC 508, a corporate director assessed under subsection 227.1 of the Income Tax Act for the source deduction arrears of his corporation put forth the argument from Gaucher, namely that the assessments issued to the corporation were incorrect and that he was entitled to challenge them. CRA's position in Barry was that the reasoning in Gaucher only applied to tax assessments issued under section 160 of the ITA and had no application to a director's liability assessment. Justice Rip of the Tax Court of Canada strongly disagreed with the position of CRA and remarked that "a taxpayer has the right to fight an assessment with all artillery available to him or her by law irrespective of the cause or origin of the assessment". The appellant director in Barry was thus allowed to proceed with their argument and challenge the validity of the underlying assessments issued to his corporation.
Conclusion – Derivative Tax Assessments
The Income Tax Act and Excise Tax Act each grant CRA extremely broad tax collection powers that dwarf those traditionally available to creditors. The ability of Revenue Canada to utilize derivative assessments to collect GST/HST and Payroll Source Deduction arrears from taxpayers other than the actual tax debtor is an example of an extraordinary tax collection remedy that would not be possible without the specific statutory grants of authority in the Income Tax Act and Excise Tax Act. One of the more effective ways to challenge derivative assessments is often for a taxpayer challenge of the accuracy of the underlying assessment issued to the initial tax debtor, especially in circumstances where the initial tax debtor failed to file returns and were arbitrarily assessed by CRA as a result.
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.