Tax Court on Derivative Tax Liability for Trusts & Trustees

Tax Court on Derivative Tax Liability for Trusts & Trustees

Tax Court on Derivative Tax Liability for Trusts & Trustees

Introduction: Derivative Tax Liability under Section 160 of the Income Tax Act & Transfers to Trustees

Section 160 of the Income Tax Act is a tax collection tool. It thwarts a taxpayer who attempts to hide assets from a Canada Revenue Agency tax collector by transferring them to a non-arm’s-length party. Basically, if you receive assets or cash from a related party—e.g., a spouse, a child, a business partner, or a trust or corporation in which you have an interest—that has outstanding tax debts, section 160 allows the CRA’s tax collectors to pursue you for that person’s tax debt. (Your liability, however, is capped at the fair market value of the transferred asset, and it is reduced by the value of what you paid in consideration for that asset. We detail the mechanics of section 160 in the following section.)

Section 160 captures a broad range of transactions, including a transfer “by means of a trust or by any other means whatever.” Yet, until the Tax Court’s decision in Goldman v The Queen, 2021 TCC 13, tax jurisprudence had featured some surprisingly unclear decisions about how the rule applied when the transferee receives the impugned property as the trustee. First, Canada’s Income Tax Act treats the trust itself as a separate entity from the trustee, so one might argue that, when a tax debtor settles property into a trust, the derivative tax liability under section 160 attaches to the trust itself, not the trustee. Second, even if the creation of a trust constitutes a transfer from the tax debtor to the trustee, the trustee receives a property of seemingly nominal value—that is, legal title without any of the other rights that come with true ownership. The Federal Court of Appeal had previously passed on the opportunity to analyze the value of the property that a trustee receives under a bare trust, and tax cases didn’t make much of the notion that derivative tax debt attaches not to the trustee but to the trust itself—that is, until the Tax Court’s decision in Goldman.

In Goldman v The Queen, 2021 TCC 13, the Tax Court of Canada shed light on derivative liability for trusts, trustees, and beneficiaries under section 160. In doing so, the court addressed some puzzling statements by the Federal Court of Appeal and provided an analytical framework that accounts for both the nominal value of legal title without beneficial ownership and a trust’s status as a separate entity under the Income Tax Act.

This article first discusses derivative tax liability under section 160 of the Income Tax Act and the concept of a trust. Afterwards, it samples some of the Federal Court of Appeal’s puzzling jurisprudence on section 160’s application to trustees. It then examines the Tax Court’s Goldman decision. Finally, this article concludes by offering expert Canadian tax lawyer tax guidance on disputing and avoiding section 160 assessments.

Section 160 of Canada’s Income Tax Act

Section 160 of Canada’s Income Tax Act aims to thwart taxpayers who try to keep assets away from the Canada Revenue Agency’s tax collectors by transferring those assets to friends or relatives.

Section 160 is a harsh rule: It offers no due-diligence defence, it applies even if the transfer wasn’t motivated by tax avoidance, and it catches transferees who don’t even realize that they’re receiving property from a tax debtor (e.g., see: Canada v Heavyside, 1996 CanLII 3932 (FCA), at para 3). In addition, section 160 doesn’t contain a limitation period. So, the Canada Revenue Agency can assess you under the rule years after the purported transfer.

Section 160 applies if all the following four conditions are satisfied:

  • A property was transferred. The language of section 160 contemplates a broad range of transfers: it covers situations where a tax debtor “transferred property, either directly or indirectly, by means of a trust or by any other means whatever.”
  • At the time of the transfer, the transferor owed a tax debt to the Canada Revenue Agency.
  • The recipient was, at the time of the transfer, one of the following: (a) the transferor’s spouse or common-law partner (or a person who has since become the transferor’s spouse or common-law partner); (b) a person who was under 18 years of age; or (c) a person with whom the transferor was not dealing at arm’s length—e.g., a trust or corporation in which the transferor has an interest.
  • The recipient paid the transferor less than fair market value for the transferred property.

When section 160 applies, the transferor and the recipient both become “jointly and severally” liable for the transferor’s tax debt. In particular, the recipient becomes independently liable for the transferor’s tax debt at the time of the transfer. This means that the Canada Revenue Agency can now pursue both the original tax debtor and the recipient for the tax debt. In fact, even if the original tax debtor is later discharged from bankruptcy and thereby released from the underlying tax debt, the recipient remains liable to the CRA (e.g.: Canada v Heavyside, ibid.)

That said, the recipient’s derivative tax liability under section 160 is capped at the fair market value of the transferred property. Moreover, the recipient’s liability is reduced by the amount of any consideration that the recipient provided for the property.  For example, a tax debtor owns a home (with no mortgage) valued at $500,000 and owes $1 million to the CRA. If the tax debtor gifts the home to her son, the son’s liability under section 160 is $500,000—i.e., the value of the home. If, on the other hand, the son purchased the home from the tax debtor for $250,000, the son’s liability under section 160 is $250,000—i.e., the value of the home minus the purchase price.

Finally, subsection 160(3) governs how payments apply to discharge the joint liability. A payment by a taxpayer who has inherited liability under section 160 shall reduce both debts—that is, this payment reduces not only the tax debt of the jointly liable taxpayer but also the tax debt of the original tax debtor. But an ordering rule governs a payment by the original tax debtor. The original tax debtor must first pay off all tax debts exceeding the joint debt.

Continuing from our previous example: the original tax debtor owes $1 million in taxes, and the joint debtor became jointly liable for $500,000 under section 160.

  • If the joint debtor pays off the full $500,000 joint debt, then he extinguishes his liability under section 160, and the original tax debtor’s liability is reduced by $500,000.
  • If the original tax debtor pays $500,000 toward her tax debt, then she reduces her amount owing by $500,000, but the joint debtor’s liability remains unchanged at $500,000.
  • If, however, the original tax debtor had paid $750,000 toward her tax debt, then she would reduce her amount owing by $750,000 to $250,000, and the joint debtor’s liability would be reduced by $250,000 to $250,000.

In other words, before her tax payments discharge the joint debt, the original tax debtor must first pay off all tax arrears that are solely her own.

Section 325 of the Excise Tax Act contains a similar rule for GST/HST debts. That is, while section 160 of the Income Tax Act covers transfers by a person with income-tax debts, section 325 of the Excise Tax Act covers transfers by a person with GST/HST debts.

The Concept of a Trust & Income-Tax Treatment of a Trust

The trust concept finds its roots in equity, a body of law developed in the English Court of Chancery and adopted by Canadian courts. Equity distinguishes legal ownership from beneficial ownership. A person legally owns a property if his or her name is on title, yet the beneficial owner is “the real owner of property even though it is in someone else’s name.” (Csak v Aumon, [1990] 69 DLR (4th) 567 (Ont. HCJ), at p. 570.)

A trust is a relationship between a trustee, a beneficiary, and a property. And it depends on the distinction between beneficial and legal ownership: the trustee legally owns the property; the beneficiary (unsurprisingly) beneficially owns the property.

The trust’s creator (a.k.a. the settlor) will often burden the trustee with duties to maintain or manage the trust property in the beneficiary’s favour. For instance, the settlor might require that the trustee manage a large sum of money for a child or disabled beneficiary.

Although a trust is a relationship between entities and not itself an entity, Canada’s Income Tax Act treats a trust as a separate taxpayer. Subsection 104(2) of Canada’s Income Tax Act deems a trust to be an individual for income-tax purposes. So, a settlement of a trust constitutes a disposition of the trust property to the trust, and the settlor may thereby trigger capital-gains tax. If the trust itself earns income, it pays income tax at the top marginal tax rate, but only to the extent that the income remains in the trust. The trust can deduct from its income any amount that it pays to a beneficiary. The beneficiary accordingly pays tax on amounts received from the trust. (A trust that qualifies as a graduated-rate estate (GRE) doesn’t incur top-rate tax on its income; a GRE’s income is taxed at progressive rates. A “graduated-rate estate” basically refers to a deceased person’s estate during the 36 months after that person’s death.)

The Federal Court of Appeal’s Puzzling Take on Trustee Liability under Section 160: The Queen v Livingston, 2008 FCA 89

One might contend that, if section 160 applies to a trustee, the resulting liability should be nominal.  A taxpayer’s liability under section 160 is capped at the fair market value of the transferred property. Legal title is arguably of nominal value if it doesn’t come with the other rights that normally accompany true ownership—e.g., the right of disposition, the right of possession, the right of use and control, the right of enjoyment, the right of exclusion, etc. Yet this vapid legal title is often what a trustee acquires upon the creation of a trust. So, because the trustee acquires a property of apparently nominal value—i.e., legal title without any substantive ownership rights—and the section 160 liability cannot exceed that amount, the trustee seemingly bears minimal liability as a result of an assessment under section 160.

Unfortunately, until the Tax Court’s decision in Goldman, this argument hadn’t found much play in the tax jurisprudence. And the Federal Court of Appeal managed to overlook the issue entirely. In Queen v Livingston, 2008 FCA 89, the Federal Court of Appeal decided that section 160 applied to the person who owned a bank account into which a tax debtor deposited funds. The Federal Court of Appeal rejected the claim that the account owner held the tax debtor’s funds in trust. Still, the appellate court proceeded to speculate upon what might have resulted if a trust had existed. The Livingston court recognized that, in the trust context, the trustee acquires legal title to the trust property, not the property itself:

Thus, subsection 160(1) categorizes a transfer to a trust as a transfer of property. Certainly, even where the transferor is the beneficiary under the trust, nevertheless, legal title has been transferred to the trustee. Obviously, this constitutes a transfer of property for the purposes of subsection 160(1) which, after all, is designed, inter alia, to prevent the transferor from hiding his or her assets. [Livingston, ibid. at para 22].

Yet the Federal Court of Appeal failed to see—or the Canadian tax litigation lawyer acting for the taxpayer failed to point out—the implication of this finding: the trustee’s liability under section 160 is therefore limited to the value of legal title without beneficial ownership. In other words, the value of the trustee’s legal title to the trust property—not the value of the trust property itself—should determine the extent of any liability under section 160.

This issue seemingly went unnoticed until the Tax Court of Canada’s decision in Goldman v The Queen, 2021 TCC 13.

Goldman v The Queen, 2021 TCC 13: Providing A Concrete Analytical Framework of Trustee Liability Under Section 160

After learning that she had only months left to live, Judith Goldman sought to get her financial affairs in order. To that end, Judith updated her will and appointed her daughter Anida as the executor of her estate.

Judith also designated Anida as the beneficiary of her Registered Retirement Savings Plan, which contained about $76,000 in net proceeds. Judith gave Anida specific directions about the use and distribution of the $76,000 in RRSP proceeds: Anida would first use the funds to pay her mother’s funeral expenses, her mother’s personal debts, and the costs of administering her mother’s estate. Anida would then equally distribute any remaining funds to herself and her two sisters.

In other words, Judith had created a trust. Although Anida was appointed as the designated beneficiary of her mother’s Registered Retirement Savings Plan, upon her mother’s death, Anida would acquire the $76,000 in RRSP proceeds in the capacity of a trustee. As such, she’d allocate those proceeds in accordance with the trust that her mother had created: first paying her mother’s bills, funeral expenses, and estate-administration costs; then distributing the residue equally to herself and her two sisters.

Upon Judith’s death, Anida received the $76,000 in net proceeds from her mother’s Registered Retirement Savings Plan. In accordance with her mother’s trust, Anida gained legal title to the entire $76,000 in net RRSP proceeds, yet she beneficially owned only one-third of the proceeds that remained after expenses.

Still, in an effort to collect upon Judith’s sizeable tax bill, the Canada Revenue Agency invoked section 160 of the Income Tax Act and assessed Anida for derivative tax liability encompassing the entire $76,000 in RRSP proceeds that Anida had acquired in the capacity of a trustee.

Anida’s experienced Canadian tax-litigation lawyer disputed the section 160 assessment by appealing to the Tax Court of Canada. She challenged not only the merits of her section 160 assessment but also the constitutionality of section 160 itself. In particular, she argued that section 160 of the Income Tax Act infringed section 7 of the Canadian Charter of Rights and Freedoms.

The Tax Court of Canada made quick work of Anida’s Charter arguments. A law violates section 7 of the Charter only if two conditions apply: (1) the law has deprived or could deprive someone of the right to life, liberty, and security; and (2) the deprivation fails to accord with principles of fundamental justice. Yet tax jurisprudence has long recognized that an income-tax assessment—including an assessment under section 160—is a civil matter involving only economic interests. As such, an income-tax assessment doesn’t deprive the assessed taxpayer of the right to life, liberty, or security. Moreover, Anida failed to demonstrate any means by which section 160 could violate a person’s right to life, liberty, or security. As a result, the Tax Court of Canada shot down Anida’s claim that section 160 was unconstitutional.

Although the Tax Court rejected Anida’s constitutional claims, Anida’s Canadian tax-litigation lawyer’s substantive arguments motivated the court to revisit the Federal Court of Appeal’s tax jurisprudence concerning the application of section 160 to trusts. Anida’s Canadian tax lawyer maintained that Anida’s derivative tax liability under section 160 didn’t amount to the entire $76,000 in RRSP proceeds because Judith had transferred these proceeds to a trust, not to Anida personally. In addition, Anida’s Canadian tax litigator argued that, as a trustee, Anida acquired only legal title to the $76,000 in the RRSP proceeds, and that legal title without beneficial interest is valueless.

The Tax Court found that Judith did indeed create a trust regarding the $76,000 in RRSP proceeds. Although the CRA’s Canadian tax counsel maintained that “an intention to avoid paying the CRA is inconsistent with the intention to create a trust,” the court disagreed. The Canada Revenue Agency alleged that Judith sought to avoid her tax debts because none of the RRSP proceeds went to the CRA. But the court clarified that this sort of intention doesn’t militate against the existence of a trust. Moreover, the court distinguished Judith’s trust from cases, like the above-mentioned Livingston decision, in which a tax debtor purports to have retained a beneficial interest in a property yet kept that property out of a creditor’s reach:

The Respondent argues that an intention to avoid paying the CRA is inconsistent with the intention to create a trust. I disagree. While the absence of instructions to pay the CRA may suggest that Judith Goldman was attempting to avoid paying her tax debts, it does not mean that she did not intend to create a trust. […]

Any intention that Judith Goldman had to avoid paying her taxes does not impact the existence of the trust she wanted to create. Judith Goldman’s situation can be distinguished from those in RaphaelLivingston and Rose. In those cases, the tax debtors claimed both to intend to defeat their creditors and to intend to maintain beneficial interest in the property in question. Faced with these conflicting intentions, the courts held that no trusts existed. These conflicting intentions are not present in Judith Goldman’s case. She had no intention of retaining beneficial ownership of the RRSP Proceeds. She specifically wanted them to go to others. Therefore, any intention that she may have had to avoid paying the CRA would have been entirely consistent with her intention to create a trust for the benefit of others and would not prevent such a trust from existing. [paras 37 & 43]

After finding that Judith had created a trust, the Tax Court detailed the mechanics of derivative tax liability under section 160 as it applies to trusts.

A trust raises the possibility of three distinct types of transfers:

  • the initial transfer of property from the settlor to the trust upon the trust’s creation;
  • the transfer of additional property to a previously created trust (e.g., additional contributions of capital to the trust or income earned by the trust); and
  • the distribution of property from the trust to its beneficiaries.

Each of type of transfer can trigger derivative tax liability under section 160 if the transferor owes tax debts to the CRA at the time of the transfer.

When a tax debtor transfers property to a trust, the derivative tax liability under section 160 attaches to the trust itself, not to the trustee personally. Under common law, a trust isn’t a separate entity. But tax law changes that. Subsection 104(2) of Canada’s Income Tax Act deems a trust to be an individual for income-tax purposes. Hence, the Tax Court reasoned, the trust’s tax debts belong to the trust itself; they aren’t personal debts of the trustee. And although the Income Tax Act obligates a trustee to use the trust’s assets to pay the trust’s tax debts, the Act doesn’t impose the trust’s tax debts on the trustee personally. “If there are insufficient assets in a trust to pay its debts,” the court explained, “the [Canada Revenue Agency] cannot simply seize the trustee’s personal assets.” Likewise, when a settlor transfers property to a trust or when a trust receives additional contributions, the trust itself—not the trustee—receives the property. Therefore, the court reasoned, a trustee “cannot be liable under subsection 160(1) because the trustee did not receive the property. It is the trust, as the recipient of the property, that may be liable under subsection 160(1) in respect of the transfer.”

On the other hand, when a trust distributes property to its beneficiaries, there are two ways that a beneficiary may attract derivative tax liability under section 160. First, if the trust distributes property to a beneficiary while the trust itself owes tax debts, the beneficiary may incur derivative tax liability under section 160. Second, section 160 captures a transfer that has been made “by means of a trust,” which captures indirect transfers through a trust. For example, a settlor transfers property to a trust, and the trust in turn distributes that property to a beneficiary. The beneficiary thereby receives a transfer “by means of a trust.” So, if the settlor also owes tax debts and deals with the beneficiary at non-arm’s-length terms, the beneficiary may incur derivative tax liability under section 160.

After shedding light on derivative tax liability for trusts, trustees, and beneficiaries under section 160, the court held that Anida’s derivative tax liability under section 160 didn’t amount to the entire $76,000 in RRSP proceeds. Judith transferred the $76,000 proceeds to a trust, not to Anida personally. As a result, while section 160 rendered $76,000 in derivative tax liability upon the trust itself, Anida didn’t personally incur that liability because there “was no transfer of property from Judith Goldman to [Anida].”

Still, the court conceded that, as the trustee, Anida acquired legal title to the $76,000 in RRSP proceeds. This concession forced the court to address the Federal Court of Appeal’s peculiar incidental remarks in The Queen v Livingston, 2008 FCA 89. As mentioned above, in Livingston, the Federal Court of Appeal opined that section 160 captures a transfer of legal title to a trustee. Yet the appellate court neglected to acknowledge that, because the value of the transferred property determines the extent of the derivative liability under section 160, a trustee’s liability under section 160 should be capped at the value of legal title.

Now, in Goldman, the Tax Court picked up on this very gap in the appellate court’s reasoning:

It seems to me that identifying the precise property that was transferred is an essential part of any subsection 160(1) analysis. Subsection 160(1) only applies if the recipient did not provide fair market value consideration for the property transferred to him or her. In order to make that determination, one has to know what property was transferred, not just that some property was transferred. Legal title alone is worth nothing. All of the value of a given piece of property lies in the beneficial ownership. The Federal Court of Appeal’s obiter comment appears to suggest that, had the Court found that Ms. Livingston had only received legal title to the deposits, it was prepared to conclude that that legal title was worth the face value of the deposits. I can conceive of no other reason why the Court would have considered it unnecessary to determine whether beneficial ownership had been transferred. If that is what the Court intended, then I respectfully disagree. […]

[W]hile obiter from the Federal Court of Appeal is very persuasive, it is not binding on me. The fact pattern in Livingston is very different from the fact pattern before me. There was no trust in Livingston. Since the Federal Court of Appeal did not have to turn its mind to how subsection 160(1) would work if a trust actually existed […].

[T]he Federal Court of Appeal’s comments in obiter in Livingston appear to suggest that the fair market value of legal title to an asset is equal to the fair market value of the asset. Again, while obiter from the Federal Court of Appeal is very persuasive, it is not binding on me. With respect, I cannot see how legal title could have any value. [paras 58, 61, and 68]

The Tax Court concluded that, even if section 160 applied to the transfer of legal title to a trustee, “the fair market value of the legal title in the [$76,000 in RRSP proceeds] was nil. Legal title in itself has no value. All of the value is in the beneficial ownership” [para 67]. Because the transferred property carried no value, section 160 imposed no liability on Anida for receiving that property.

So, one way or the other, Anida’s derivative tax liability under section 160 didn’t amount to $76,000. On one hand, Judith transferred the RRSP proceeds to a trust, not to Anida. On the other, if, by creating the trust, Judith did in fact transfer a property to Anida, that property was worthless: legal title without beneficial ownership.

Next, the court turned its attention to the amounts that Anida received from the trust that her mother had created. In particular, the trust paid Anida about $28,000 of the $76,000 in RRSP proceeds that Judith had settled into the trust:

  • $4,500 as payment for the services that Anida had rendered as the executor of her mother’s estate;
  • $8,100 as reimbursement for amounts that Anida allegedly paid toward her mother’s funeral expenses and final bills;
  • $5,000 as payment toward Anida’s personal legal costs for disputing her derivative tax liability under section 160 of the Income Tax Act; and
  • $10,400 as distribution of Anida’s beneficial interest in the trust that her mother had created.

The court concluded that section 160 applied to each payment, except the $4,500 that Anida received for services rendered. Each payment constituted a transfer that Anida had received from a tax debtor—namely, either from Judith, who transferred them to Anida “by means of a trust” or from the trust, which had itself inherited derivative tax liability under section 160 when Judith settled property into the trust.  Moreover, Anida was not only the trustee but one of the trust’s beneficiaries. So, she and the trust dealt with one another at non-arm’s length. Thus, section 160 applied to both the $5,000 payment that Anida had received for her legal fees and the $10,400 distribution because she received these payments without providing consideration. The court also decided that section 160 applied to the alleged $8,100 reimbursement for funeral expenses. The court found that Judith’s funeral expenses were paid with funds from another bank account containing Judith’s savings. Anida didn’t pay the funeral expenses with the $8,100 that she had received from the trust; the $8,100 had simply been deposited into Anida’s own bank account. But Anida didn’t incur derivative tax liability on the $4,500 payment because her services as an executor constituted fair-market-value consideration.

In the end, the court granted Anida’s appeal and ordered the Canada Revenue Agency to reduce her derivative tax liability under section 160 from $76,000 to $23,000, which comprised the amounts that Anida received from the trust without providing consideration.

Canadian Tax Guidance from a Canadian Tax Lawyer – Avoiding & Responding to Derivative Tax Assessments Under Section 160

If you have outstanding tax debts and transfer property to your friends and relatives in an attempt to keep assets away from the Canada Revenue Agency, you expose them to CRA collections action. But the Goldman case demonstrates that, even if you’re not attempting to dodge CRA tax collectors, section 160 might rear its ugly head.

If you plan on entering a transaction with a related party, including any transaction involving a trust, and either you or that party has tax debts (or might later be reassessed for a prior tax year), consult one of our expert Canadian tax lawyers for advice on reducing your exposure to a derivative tax assessment under section 160.

The Goldman decision limits the scope of trust transactions that the CRA may consider for section 160 assessments. Goldman also limits the scope of a trustee’s exposure to derivative tax liability under section 160. And although Goldman concerned section 160 of the Income Tax Act, its reasoning likely extends to derivative tax assessments under section 325 of the Excise Tax Act. The Excise Tax Act’s definition of an “individual” doesn’t include a trust, but its definition of a “person” does. Hence, when a tax debtor transfers property to a trust, the trust itself—not the trustee—should be the target of the derivative tax assessment under either section 160 of the Income Tax Act or section 325 of the Excise Tax Act.

That said, the Goldman case doesn’t limit the scope of a beneficiary’s derivative tax liability, and a trustee who personally appropriates trust funds remains completely exposed to derivative tax liability under section 160 of the Income Tax Act. Moreover, the jurisprudence is still evolving, and it remains unclear what the Federal Court of Appeal will make of the Tax Court’s Goldman decision.  If you plan on settling a trust, winding up a trust, or structuring any transaction involving a trust, such as an estate freeze, consult with one of our expert Canadian tax lawyers, who thoroughly understand these tax-planning transactions and the jurisprudence surrounding section 160. Likewise, if you’re assessed for derivative tax liability under section 160 as a result of a tax-planning transaction or a transaction involving a trust, or if you’re assessed under section 160 because you obtained property or funds in the capacity of a trustee (you believe that you might have been a trustee), you should consult with one of our top Canadian tax lawyers. Our experienced Canadian tax lawyers can ensure that you deliver a forceful, thorough, and cogent response to the Canada Revenue Agency.

If you receive a notice of assessment under section 160 of the Income Tax Act or under section 325 of the Excise Tax Act, you may challenge both the merits of the assessment itself and the underlying tax debt by filing a notice of objection within the prescribed time limit. In addition, you may challenge the underlying tax debt even if the original tax debtor failed to do. If the original tax debtor did in fact challenge the debt but failed to lower the amount, you may still challenge the underlying tax debt—and you may raise independent arguments.

But you have only a limited amount of time to object to the section 160 assessment. If you don’t exercise your appeal rights within the statutory deadlines, you’ll be personally stuck with the debt even if the original tax debtor goes bankrupt.

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