The tax debt trap hiding in plain sight

Log in to listen to this article

Every day, assets change hands between people who trust one another. A parent adds a child to a title. A spouse takes sole ownership of the family home. An owner tidies up the books before a sale. Almost no one thinks of these events as tax planning. They considered family arrangements, estate steps, or ordinary corporate housekeeping. 

Then a letter arrives from the Canada Revenue Agency (CRA), advising that the recipient of the asset may be liable for the transferor’s unpaid taxes.

That is the force of section 160 of the Income Tax Act. It is not new or exotic, but it’s highly underestimated. Put simply, its purpose is to preclude a tax debtor from putting property beyond the CRA’s reach by passing it to someone close for less than fair market value. 

However, a simple purpose does not mean simple consequences.

There are four core conditions for the application of the rule: 

1. There must be a direct or indirect transfer of property; 
2. At the time of transfer, the transferor and transferee must not be dealing at arm’s length;
3. At the time of transfer, the transferor must owe tax; and
4. The transferee must give less than fair market value consideration for what they receive. 

If these conditions are met, the transferor and transferee may be jointly and severally, or solidarily liable for the value gap between what was received and what was paid. 

Section 160 does not ask whether the transferee knows about the tax debt. It does not require fraud. It has no limitation period. Liability can attach when the transfer happens and surface years later, when memories fade, and documents are missing. For taxpayers, the rule can feel like a surprise. For advisers, surprise is exactly the problem.

A common misunderstanding is that section 160 only catches intentional attempts to avoid a tax debt. It can also catch relatively ordinary transactions, such as a dividend from a corporation with a tax debt or a transfer of title to a spouse or child for nominal consideration. A corporate reorganization may invite scrutiny if property is transferred over a series of steps. 

Even seemingly independent corporate shareholders may not be safe. In McCague, after dividend payments from a corporation with a tax debt to its two equal shareholders were found to be for personal needs rather than a business purpose, the Tax Court of Canada (TCC) found the shareholders to be dealing at non-arm’s length with the corporation for purposes of section 160.  

Past judgments kept section 160 anchored to its text. In Eyeball Networks, the Federal Court of Appeal (FCA) found that it should be applied separately to each transaction that comprises a corporate reorganization. In Microbjo, the FCA followed Eyeball Networks in finding that each transfer in a chain of transactions must independently meet the conditions of the section for liability to cascade down the chain to the ultimate transferee.   

In certain circumstances, more recent judgments have broadened the application of section 160. In Harvard Properties, the TCC found that, even if each transfer in a chain of transactions independently meets the section’s conditions, the general anti-avoidance rule under section 245 can apply to ignore those transfers that frustrate section 160’s overall purpose. The FCA overturned the TCC judgment in August. 

Legislative changes and budgetary proposals in the last five years have added, and propose to add, new rules under section 160 to stop tax plans designed to sidestep the conditions for its application, and to penalize promoters of these plans. 

The application of section 160 to real estate, estate and probate planning should also be considered. In Gill, the TCC found that a transfer of legal title in a family home between family members is sufficient to apply section 160 even where a transferee ultimately receives no beneficial interest. This decision leaves unresolved how section 160 liability should be quantified when a transferee acquires legal title but no corresponding beneficial interest. Until that issue is clarified on appeal, arrangements involving bare trusts or the addition of relatives to title should be reviewed for potential section 160 exposure. It cannot be assumed that no beneficial transfer means no section 160 problem.    

Avoiding the trap

While not all related-party transfers are at risk of invoking this provision, it has sharp edges. Before property moves, advisers should test the section’s four conditions, check existing and potential tax debts, value the consideration, document the commercial purpose, and preserve evidence of beneficial ownership if title and economics diverge. 

Even after taking the precautions to plan around the text of section 160, advisers should always ask if their plan might frustrate its overall purpose.    

For taxpayers, the stakes are personal. Someone can receive an asset one day and face another person’s tax bill years later. 

For advisers, the stakes are professional. Treating section 160 as an afterthought when planning can leave clients exposed and, under the added rules, create a penalty risk.

As taxpayers witness the largest-ever transfer of intergenerational wealth, they can expect increasing potential for the tethering of tax debts to shareholder payments, reorganizations, and family transfers. But with the right advisor, they do not need to expect a section 160 tax assessment. 
 

Views expressed are not necessarily those of the Canadian Bar Association. This article does not constitute legal advice.