CRA goes after enterprise proprietor who gave himself dividends

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Many retail traders are actually conversant in the idea of dividend revenue, having obtained it both by way of direct possession of publicly traded shares or, not directly, by means of the possession of mutual funds that movement dividends out to them.

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In these circumstances, dividends symbolize the investor’s share of company after-tax income {that a} company has determined to distribute to its shareholders reasonably than retain for its personal use.

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However in the event you’re a enterprise proprietor who owns an included enterprise, together with knowledgeable company, dividends are typically considered a type of remuneration. Contemplate a enterprise proprietor who owns 100 per cent of the shares of their company. To extract funds from their enterprise to stay on, they’ll select to pay themselves a wage or, as the only real shareholder, have the company pay them a dividend.

However a dividend just isn’t legally thought-about remuneration, which might have extreme implications for a enterprise proprietor, as one Delta, B.C., taxpayer not too long ago came upon. The taxpayer, a chartered skilled accountant and licensed insolvency trustee, was in Tax Court docket in September to problem a Canada Income Company evaluation beneath part 160 of the Earnings Tax Act.

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Part 160, also referred to as the “joint legal responsibility rule,” offers the CRA the ability to carry a person answerable for the tax money owed of somebody with whom they’ve a non-arm’s size relationship in the event that they’ve been concerned in a transaction seen to keep away from tax.

“Non-arm’s size” refers to people who’re associated, usually blood kin, spouses or common-law companions, in addition to a company and its shareholders, and anybody else the CRA believes is factually not at arm’s size with one another.

4 standards should be met for the CRA to efficiently win a joint-liability evaluation: there should have been a switch of property; the transferor and the transferee should not have been dealing at arm’s size; there should not have been satisfactory consideration paid by the transferee to the transferor; and the transferor should have had an impressive tax legal responsibility on the time of the switch.

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Within the latest case, the taxpayer was reassessed in 2017 beneath part 160 for a switch of property from his company to him in December 2015 at a time when the company had a tax legal responsibility owing. On this case, the switch of property was within the type of dividends within the quantities of $140,500 paid to the taxpayer and $1,000 paid to his household belief. Each dividends had been declared and licensed by a written decision of the taxpayer, who was the company’s sole director and controlling shareholder.

On the time of the switch, the company had a tax legal responsibility excellent of almost $110,000, representing the entire federal and provincial tax owing, plus accrued curiosity. The difficulty to be determined by the Tax Court docket was whether or not the taxpayer ought to be held collectively and severally answerable for the $110,000 of tax owed by the company pursuant to part 160.

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In court docket, the taxpayer argued the dividends paid to him had been in consideration for companies he offered to the company as a person licensed insolvency trustee. He maintained the dividends had been paid to him personally to retain his companies. “In at the moment’s enterprise world, dividends are a authentic and legitimate type of remuneration for executives, key personnel and principals of an organization,” the taxpayer testified.

Three of the 4 part 160 standards listed above had been clearly met, however the taxpayer and the CRA disagreed as as to if or not the taxpayer offered consideration (his companies) for the property (the dividends) transferred to him by the company and, in that case, whether or not the honest market worth of that consideration exceeded the honest market worth of the property transferred to him.

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The taxpayer stated the skilled companies he offered to the company had been the consideration he offered to the company in return for the dividends. However this argument has failed previously because of the inherent nature of dividends.

The Tax Court docket referred to a seminal 1998 determination of the Supreme Court docket of Canada that decided a dividend is expounded to shareholding and to not another consideration the shareholder may need offered.

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“A dividend is a fee which is expounded by the use of entitlement to at least one’s capital or share curiosity within the company and to not another consideration,” the Supreme Court docket wrote. “Thus, the quantum of 1’s contribution to an organization, and any dividends obtained from that company, are mutually unbiased of each other.”

In a previous case, the Supreme Court docket wrote, “To narrate dividend receipts to the quantity of effort expended by the recipient on behalf of the payor company is to misconstrue the character of a dividend … (A) dividend is obtained by advantage of possession of the capital inventory of a company. It’s a elementary precept of company legislation {that a} dividend is a return on capital which attaches to a share, and is under no circumstances depending on the conduct of a selected shareholder.”

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The taxpayer additionally tried to argue that he reported the dividends on his private revenue tax return and paid taxes on them, thus the dividends had been akin to fee for his companies. However the Tax Court docket choose disagreed, concluding the “declaration of a dividend is, in company legislation, an allocation of an organization’s undistributed income to its shareholders and doesn’t rely upon the conduct of a given shareholder.”

Since no consideration was given by the taxpayer for the dividends, the choose discovered the taxpayer to be collectively and severally answerable for the tax owing beneath part 160 of the Earnings Tax Act.

Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Property Planning with CIBC Personal Wealth in Toronto. Jamie.Golombek@cibc.com

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