A Canadian Tax Lawyer Guide to Third-Party Tax Liabilities under Section 160 and Section 325

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A Canadian Tax Lawyer Guide to Third-Party Tax Liabilities under Section 160 and Section 325

Introduction to Third-Party Tax Liabilities under Section 160 and Section 325

Section 160 of the Income Tax Act and Section 325 of the Excise Tax Act are derivative tax liability provisions. This means they empower the Canada Revenue Agency to pursue other people, third parties, for the unpaid income taxes and GST/HST, respectively, of a taxpayer. These sections are intended to prevent taxpayers from evading paying taxes by simply shifting their assets to another person. Despite the reason for these provisions, the sections are broadly drafted and of general applicability and the intention of the taxpayer in transferring assets is not relevant in assessing tax liability under Section 160 or Section 325.

There are limitations to the above sections. Section 160 and Section 325 apply only to transfers of assets for less than fair market value consideration from the original tax debtor to a person who is non-arm’s length to the tax debtor. Assets may include money, shares, Cryptocurrency, vehicles, property and other assets.

The tax liability resulting from Section 160 and Section 325 is the lesser of:

  1. The outstanding tax debt of the original tax debtor
  2. The fair market value of the asset transferred less the value of any consideration given by the transferee for the asset

The tax liability is considered joint and severable between the original tax debtor, and any transferees. Any payment towards the tax debt can impact the amount owed by the original tax debtor or any transferees. To illustrate, assume Joe owes $30,000 to the Canada Revenue Agency and decides to gift his three adult children – Sarah, Fred and Ted – $10,000 of bitcoin each. The Canada Revenue Agency issues a Section 160 assessment against each of Sarah, Fred and Ted for $10,000 each. The following situations are independent of each other.

  1. Joe pays $30,000 to the CRA. His tax debt, and that of his children, is satisfied.
  2. Sarah pays $10,000 to the CRA in response to her Section 160 assessment. She no longer owes money to the CRA, and Joe’s tax debt is decreased to $20,000. However, Fred and Ted still each owe $10,000 to the CRA since Joe’s overall tax debt still exceeds $10,000.
  3. Joe pays $10,000 to the CRA. His tax debt is decreased to $20,000. However, Sarah, Fred and Ted still each owe $10,000 to the CRA since Joe’s overall tax debt still exceeds $10,000.
  4. Joe pays $22,000 to the CRA. His tax debt, and the tax debt of his children, is decreased to $8,000 each.
  5. Sarah, Fred and Ted each pay $10,000 to the CRA. Joe’s tax debt, and each of his children’s tax debts, are satisfied.

Arm’s Length under the Canadian Income Tax Act

Related persons are always deemed to be non-arm’s length to each other. Related persons are “blood relationship, marriage, common-law partnership, legal adoption or adoption in fact. A corporation and another person or two corporations may also be related persons. In addition, for GST/HST purposes, a member of a partnership is related to the partnership.” according to the Canada Revenue Agency. For income tax, a taxpayer and trust where the taxpayer is beneficially interested in the trust subject to certain limitations are also related persons.

Unrelated persons may also be deemed to be non-arm’s length to each other. This will be a factual determination in each case.

Timing of the Transfer of Assets To Avoid Taxes

The timing of the asset transfer and tax debt is relevant to the tax liability under Section 160 and Section 323. The transferee can only be assessed for the tax debt of the transferor related to the tax year or reporting period when the transfer occurred, or any prior tax year or reporting period of the transferor.

For example, Joe gifts his wife Melissa an expensive ring in 2020. Joe then decides he does not like his 2021 tax year assessment and refuses to pay the Canada Revenue Agency the tax amount he owes. The Canada Revenue Agency cannot pursue Melissa for Joe’s unpaid tax debt because the gift occurred in the tax year prior to Joe’s tax debt arising.

However, having no tax debt at the time of asset transfer does not extinguish the possibility of derivate liability under Section 160 or Section 325. The transferor may be later reassessed for the tax year or reporting period where the asset transfer took place, or any tax year or reporting period prior to when the asset transfer took place and thus incurs a tax debt. The wording of Section 160 and Section 323 suggests that the transferee could then be assessed for the transferor’s unpaid tax debt related to the aforementioned reassessment(s).

Returning to the above example of Joe and Melissa. Joe gives Melissa the ring in 2020. In 2021, he is audited and reassessed for his 2018 taxation year leaving Joe with a large tax bill for his 2018 taxation year. Here, the Canada Revenue Agency could pursue Melissa for Joe’s tax debt related to the 2018 taxation year because the transfer of the ring occurred in a subsequent tax year.

In Colitto v. Her Majesty the Queen, 2020 FCA 70, the taxpayer transferred assets to his wife in 2008. In the same year, the corporation of which the taxpayer was director failed to remit payroll deductions and did not rectify the issue in the next three years. The court found that the taxpayer’s liability existed as soon as the corporation failed to remit its payroll deductions. Since this was a tax year he transferred the assets to his wife, his wife could be held liable under Section 160.

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Lastly, there is no limitation period on Section 160 or Section 325 assessments, meaning the Canada Revenue Agency can make a Section 160 or Section 325 assessment at any time provided the conditions to make such an assessment are met.

Types of Asset Transfers – Attract Section 160 and 325 Liability

The following asset transfers are likely to attract Section 160 and Section 325 liability because they do not typically involve fair market consideration.

  • Gifts
  • Dividends
  • Shareholder Benefits
  • Shareholder Draws
  • Distributions upon dissolution of a partnership, trust or corporation or death of an individual
  • Transfers at less than fair market value

Types of Asset Transfers – Avoiding Section 160 and 325 Liability

The following asset transfers do not normally attract Section 160 and Section 325 liability because they are typically payments made in exchange for consideration of the same value.

  • Management Fees
  • Salaries and other renumeration for services
  • Sale of goods or services for fair market value
  • Loans, including shareholder loans

However the rule that the consideration must be equal to fair market value of the transferred asset to avoid Section 160 or Section 325 liability still applies to these transfers. For loans, that means repayment of the loan. If insufficient consideration is provided in exchange for these transfers of assets, Section 160 or Section 325 liability may still be incurred equal to the lesser of:

  • The difference between the fair market value of the asset(s) transferred and the consideration received for those assets
  • The outstanding tax debt of the transferor.

Further, if the consideration greatly exceeds the value of the asset(s) transferred, the Canada Revenue Agency may argue that the payment for the assets transferred were a different type of payment.

For example, Joe owes income tax to the Canada Revenue Agency and is the sole shareholder of a corporation. Joe purchases a company owned vehicle from the corporation. Instead of paying the car’s fair market value of $5000, Joe pays $20,000. The Canada Revenue Agency will argue that Joe’s car purchase is not a legitimate transaction and he is using the purchase to disguise a transfer of funds to the corporation. It will state that there is no fair market consideration for the $15,000 difference and that it can pursue the corporation for Joe’s unpaid taxes under section 160 for that $15,000 amount.

Pro Tax Tips: Defeating a Section 160 or Section 325 Assessment

Our experienced Canadian tax lawyers can assess your specific circumstances to advise on the best strategy to fight a Section 160 or Section 325 assessment. Some common strategies and arguments include:

  • Have the original tax debtor either object to the underlying tax debt or pay the underlying tax debt
  • Have the transferee object to the Section 160 or Section 325 assessment with one or more of the following arguments.
    • That the assessment or reassessment of the original tax debtor is wrong and excessive
    • The tax debt is related to a period after the transfer of the asset
    • The transferee never received all or part of the asset(s)
    • The CRA estimate of the value of the assets transferred is wrong and excessive
    • The transferee provided fair market value compensation for the asset(s) transferred

Our knowledgeable Canadian tax lawyers additionally recommend being proactive to avoid Section 160 and Section 325 debts for yourself, or those you are not arm’s length to.

  • Ensure your taxes are filed correctly, and on time. This will limit the Canada Revenue Agency’s ability to reassess you, and prevent a much higher arbitrary or notional assessment being issued. Our lawyers can advise on how to file, or correct past filing issues.
  • Ensure all debts to the Canada Revenue Agency are paid. Our tax lawyers can assist with negotiating payment plans with the Canada Revenue Agency to make paying tax debts more manageable and limit the likelihood of a Section 160 or Section 325 assessment for anyone you are not arm’s length to.
  • Document the transfers described under the “Types of Asset Transfers – Avoiding Section 160 and 325 Liability” section above. One issue transferees commonly run into is proving to the Canada Revenue Agency that funds or other assets they received were in exchange for consideration and the value of that consideration. Proper documentation assists in combating this.

F.A.Q.

What is Section 160 of the Income Tax Act and Section 325 of the Excise Tax Act?

These are derivative tax liability provisions that allow the Canada Revenue Agency to pursue other people for the unpaid income taxes and GST/HST, respectively, of a taxpayer, where the taxpayer has transferred assets to a non-arm’s length party for less than fair market value.

What are some of the limits on Section 160 of the Income Tax Act and Section 325 of the Excise Tax Act?

  • Liability assessed under these provisions cannot exceed the fair market value of the asset transferred less any consideration the transferor received from the transferee for that asset.
  • The asset must have been transferred in the tax year the transferor’s tax liability arose or a subsequent year.
  • The underlying tax debt must be properly assessed