As we have blogged about a fewtimes in the past, corporate tax debts are unlike other forms of liability and can pose special challenges for directors and shareholders of corporations that have unmet tax obligations.  This can lead to dreaded director’s liability and third-party assessments, which allow the CRA to effectively “pierce the veil” and go after individuals or other businesses that would otherwise be protected by the screen of limited corporate liability.

A recent decision at the Tax Court of Canada considered this issue, serving as a reminder to businesses and their owners that these debts are not so easily ignored.

Background

The taxpayer, Michelle Kufsky, was the owner and director of a home décor business that operated through a corporation, Mon Refuge Décor Inc.  The corporation had an unpaid tax debt (of around $70,000) for its 2008 and 2010 taxation years but had made payments to Ms. Kufsky totaling $85,000 between 2009 and 2011 (which were characterized as dividends by Ms. Kufsky’s accountants in an amended income tax filing).

(The fact that these payments might have been dividends was potentially problematic because transfers from a corporation which owes tax debts at that time are potentially assessable in the hands of the person receiving them.)

Ms. Kufsky was audited and claimed that these reported dividends were not dividends at all, and actually represented an annual “balancing of the books” to reconcile her use of corporate accounts during the year.  CRA disagreed and levied a “third-party assessment” which found her personally liable for the tax debt of the corporation.  This was then appealed to the Tax Court.

Tax Court Decision

On appeal, the Tax Court was tasked to determine whether Ms. Kufsky was personally liable for corporation’s tax debt.  The Tax Court rejected Ms. Kufsky’s arguments, finding that there was no consideration for the dividends, as they flowed from her status as a shareholder and not from any services or loans she provided to the corporation.  Fundamentally, the dividends were valid transfers of property for tax purposes, even if they were not properly issued under provincial corporate law, which did not affect Parliament’s ability to tax them.

The evidence did not support the claim that some of the dividends were loan repayments, and the Tax Court could not recharacterize the payments as something else.  Accordingly, the Tax Court dismissed the appeal and upheld the assessment.

Commentary

This case serves as a reminder for taxpayers who receive ANY transfers from corporations at the time they owe CRA tax debts that all such transfers are assessable in the hands of the person receiving them.  Section 160 of the Income Tax Act (and its corresponding provision at section 325 of the Excise Tax Act) are powerful tools in CRA’s arsenal to collect taxes from third parties who are not at arm’s length with tax debtors.  These powers follow the well-established director’s liability rules under both statutes which similarly hold directors liable for tax debts incurred by the corporation under their watch.

If a corporation has a tax issue, its directors/shareholders will likely need to address it proactively and with expert advice — otherwise they risk having to deal with CRA’s long-reaching assessing and collection powers.

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