The Long Arm of Section 160

The following article on section 160 of the Income Tax Act (Canada) appeared in the latest edition of the Hamilton Law Association Law Journal. It is an expanded version of one of my posts from August.

Section 160 of the Income Tax Act (the “Act”) permits the CRA to assess “at any time” a taxpayer who receives property for inadequate consideration from a non-arm’s length tax debtor. The CRA can use the section to chase down assets that a tax debtor has “given away” in an attempt to avoid liability under the Act. But the scope of the section is actually much broader than that. Section 160 gives the CRA very long arms indeed when it is trying to reach into a taxpayer’s pocket. This article examines how section 160 works both in theory and in practice.

Section 160 in Full

Section 160 applies if

(1) a person transfers property “directly or indirectly”

(2) to the person’s spouse, a child or to a person with whom the person was not dealing at arm’s length.

That’s it; those are the only conditions to the application of section 160. Note what is not a condition. Intention and section 160 have nothing to do with each other. A tax debtor might make a gift of property to a family member, and both of them might be ignorant of any obligation to the CRA for unpaid taxes. The CRA can still use section 160 to reassess the family member because the two conditions set out above have been met.

Section 160 will apply if a taxpayer transfers property to a child even if the child and the taxpayer are unrelated and otherwise deal at arm’s length. Of course, the section also applies to transfers to non-arm’s length persons. The Act and the income tax jurisprudence give a rather technical meaning to ‘arm’s length’. For a brief review of the meaning, see my article on section 84.1 of the Act in the last issue of the Journal. It is suggested, however, that the CRA would likely attempt to apply section 160 in any case where a tax debtor transferred property to another person for consideration that was significantly less than the fair market value of the property. The CRA would probably argue that the inadequacy of the consideration was proof positive of a non-arm’s length relationship.

Where section 160 applies, the transferor and transferee are jointly and severally liable to pay the transferor’s tax under the Act. The amount of the liability is equal to the lesser of

(1) the difference between the fair market value of the transferred property at the time of the transfer and the consideration given for the property; and

(2) the tax liability of the transferor for the year in which the transfer is made or in any preceding year.

Section 160 could apply to many different kinds of property transfers including

(1) dividends paid by a corporation to a non-arm’s length or controlling shareholder;

(2) gifts;

(3) bequests;

(4) mortgage payments on a home owned by a spouse; and

(5) contributions to a spouse’s RRSP.

The section does not apply to a loan, if the parties can prove that the transferee had the obligation to repay the amount transferred.

Section 160 will apply to a series of transfers. Assume that father owes an amount to the CRA, and he transfers the property to his wife, who transfers the property to her daughter, who transfers the property to her brother. The wife, the daughter and the son are all potentially liable under section 160!

The CRA is entitled to assess a transferee under section 160 at any time. As will be seen below, this can result in assessments being issued long after the taxation year to which the primary liability relates.

So much for an outline of section 160. The following section of this article will review the application of section 160 in practice by summarizing several relevant and more or less recent tax court cases.

Section 160 in Practice

Shirafkan — Consideration

Shirafkan v. The Queen, 2007 TCC 309, considered the question of the adequacy of consideration. The husband owned the family home. He was a director of a corporation that failed to remit source deductions and GST, and so he was assessed personally for the failure. He transferred the family home to his wife at a time when he was liable for the failure to remit. The CRA, then, assessed the wife under section 160 for the husband’s tax debts.

The wife was able to prove that the husband owed amounts to her under a marriage contract and that, using her own funds, she had repaid a significant portion of the mortgages taken out on the home by the husband. The evidence showed that the husband acknowledged that, because of the payments she had made on the mortgage, the house “belonged to her” at the time of the transfer. Mr. Justice Bowie of the Tax Court, therefore, concluded that the husband intended to discharge the debts he owed by transferring the house and that the wife had given adequate consideration for the home. The wife’s appeal was allowed and the 160 assessments were vacated.

Wannan — Bankruptcy

What is the effect of bankruptcy on a section 160 assessment? Does the CRA have discretion over how to apply payments against a transferor’s liability in the context of a 160 assessment? Consider Wannan v. The Queen, 2003 FCA 423. Dr. Wannan owed amounts to the CRA in respect of his 1988, 1989 and 1995 taxation years. The amounts owing for 1988 and 1989 were relatively small; the amount for 1995 was quite large. Dr. Wannan, in 1989 through 1995, made gratuitous contributions to his wife’s RSP. The contribution for 1995 was relatively small. Early in 1996, Dr. Wannan went bankrupt. Some time before February, 1999, the CRA received an interim dividend from Dr. Wannan’s estate. The CRA proceeded to apply the interim dividend to Dr. Wannan’s liability arising in 1995, leaving amounts outstanding for 1988 and 1989.

Not coincidentally, the largest contributions to Ms. Wannan’s RSP occurred before 1995. If the CRA had applied the interim dividend to the oldest debts first, Dr. Wannan would not have been a tax debtor at the time he transferred amounts to his wife’s RSP in 1988 and 1989. The CRA did not apply the interim payments in this manner, however. Instead, it applied the dividends it received to the 1995 liability, which the payment did not eliminate. The CRA then proceeded to assess Ms. Wannan under section 160 in February, 1999. Was the CRA entitled to proceed in this manner?

According to the Federal Court of Appeal, it was. The Court confirmed its own decision in Heavyside v. The Queen, 1996 CanLII 3932. The Court summarized Heavyside as follows:

Heavyside can be taken as authority for at least three propositions. (1) Liability under section 160 of the Income Tax Act arises upon a transfer of property in circumstances that meet the statutory conditions, not on the date on which the liability is assessed. (2) A section 160 liability survives the bankruptcy of the principal tax debtor. (3) A section 160 liability survives the bankruptcy discharge of the principal tax debtor. The statutory basis of the third proposition is that although subsection 178(2) of the Bankruptcy and Insolvency Act provides that a discharge relieves the bankrupt person from liability for a debt proved in the bankruptcy, section 179 of that Act prevents the discharge from giving the same relief to a person who, at the date of the bankruptcy, was jointly liable for the debt.

The bankruptcy of Dr. Wannan, then, did not eliminate the derivative liability of his wife.

What about the manner in which the CRA applied the debt? The Court acknowledged that, ordinarily,

the Crown will recognize the right of a taxpayer paying his or her own tax liability to direct how the payment should be applied. It has also been established that if a tax payment has initially been applied in a particular way, the Crown and the taxpayer may agree that it will be applied in a different way: The Queen v. Union Gas (1990), 116 N.R. 220, [1991] 1 C.T.C. 1, 90 D.T.C. 6659 (F.C.A.). However, I am aware of no case in which the Crown was compelled to apply a tax payment to a particular tax debt if the payment is not directed to that debt, and there is no agreement between the payer and the Crown as to how the payment is to be applied.

The Court, therefore, concluded as follows:

The argument for Ms. Wannan is that the Crown should be bound by its normal first in, first out practice. Just as the Court in Clayton’s Case found it unfair to the bank (or its unsecured creditors) for a single depositor to be able to reconstruct the application of payments after the fact, counsel for Ms. Wannan argues that, when the Crown is determining the amount to be assessed against Ms. Wannan under section 160, the Crown should not be able to make unilateral retroactive adjustments to Mr. Wannan’s tax account.

The argument for Ms. Wannan rests on a single fact, which is that the Crown normally maintains a single running account for each tax debtor. Counsel for Ms. Wannan referred to no statutory requirement for such an accounting method. Nor is there any evidence as to why the Crown keeps its accounts as it does; I assume it is a matter of convenience. The practice of the Crown in keeping track of a tax debt as a running account seems to me to be an insubstantial basis for extending the first in, first out rule in Clayton’s Case to all tax debts. For that reason, I am not persuaded that in this case, there is any reason to preclude the Crown from applying the bankruptcy dividend as it did, to the newest of Dr. Wannan’s tax liabilities.

Addison & Leyen Ltd. — Limitations

In The Queen v. Addison & Leyen Ltd., 2007 SCC 33, the CRA issued a notice of reassessment to a corporation in 1992 in respect of its 1989 taxation year. The corporation had purchased seismic data and claimed large tax deductions for it. The reassessment, of course, increased the income tax debt of the corporation by denying the deductions for the data. Certain shareholders of the corporation had received payments from the corporation in 1989. They then sold their shares in that same year. The CRA apparently determined that the corporation could not pay the tax debt created by the 1992 assessment, and so, nine years later, in 2001, when the amount originally reassessed against the corporation had nearly doubled, it issued section 160 assessments against the shareholders. Just how far can you stretch “at any time” anyway?

Pretty far, according to the Supreme Court of Canada. The Federal Court of Appeal (in 2006 FCA 107) had held that judicial review was available to challenge the length of time the CRA had taken to assess under section 160. The Supreme Court, however, allowed the CRA’s appeal. The headnote summarizes the Court’s decision:

On the facts of this case, judicial review was not available because the Minister can reassess at any time as s. 160 of the Income Tax Act contains no limitation period. This does not mean that the exercise of this discretion is never reviewable, but the length of the delay before a decision whether or not to assess is not enough to ground judicial review. The length of delay might, however, ground a remedy like mandamus to prod the Minister to act with due diligence. Furthermore, the allegations of fact here did not show that the regular appeal process could not have dealt with the tax liability issues.

Mandamus will be useless to a taxpayer who has no idea that the CRA is contemplating an assessment under section 160. In Addison & Leyen Ltd., the taxpayers had sold their shares in 1989 soon after receiving the dividends and other payments that attracted the application of section 160. Perhaps the taxpayers had nothing to do with the corporate payer after 1989, and so they might have had no knowledge of the reassessment. The 160 assessments in 2001 — twelve years after they had disposed of their interests in the corporate payer — might have come as a bolt from the blue.

In addition, a taxpayer’s ability to challenge an assessment will be severely compromised if it relates to a taxation year that is more than a decade in the past. Memories fade, documents are misplaced. Our legal system has limitation periods for many good reasons, but apparently in the Wonderland that is our tax law the writ of the reasons does not run. The problem is compounded by the fact that an assessment under section 160 is derivative: by definition it relates to the affairs of another person, over whom the assessed taxpayer might have very little influence (even if legally they deal not at arm’s length). A person assessed under section 160 will often not have the information and evidence needed to contest the underlying assessment.

Conclusion

Section 160 is an important weapon for the CRA in its fight to preserve Canada’s tax base and collect taxes from sometimes uncooperative or dishonest taxpayers. It is also a powerful weapon that can have harsh and unintended consequences. Taxpayers who seek to avoid their obligations under the Act by means of financial shell games will find it difficult to work around the provisions, and honest taxpayers should take comfort from the fact. On the other hand, the section can cause real grief to the innocent, the unwary and the clueless, especially in the hands of the CRA tortoise that chases the taxpayer hare.