Section 160 Brown v The Queen

Introduction – The Harsh Results of Vicarious Tax Liability under Section 160 of the Income Tax Act

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—and that related party has outstanding tax debts, then section 160 allows the CRA's tax collectors to pursue you for that person's tax debt. (Your liability 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.)

Courts readily admit that section 160 can lead to unfair results:

While not every use of section 160 is unwarranted or unfair, there is always some potential for an unjust result. There is no due diligence defence to the application of section 160. It may apply to a transferee of property who has no intention to assist the primary tax debtor to avoid the payment of tax. Indeed, it may apply to a transferee who has no knowledge of the tax affairs of the primary tax debtor [Canada v Heavyside, 1996 CanLII 3932 (FCA), at para 3].

So, the Tax Court of Canada and the Federal Court of Appeal have long struggled with the CRA's application of section 160 in cases bearing sympathetic facts. Brown v The Queen, 2020 TCC 45, is yet another example.

Yet Brown offers something more. It hints at a means by which taxpayers can guard themselves from derivative tax liability when they receive funds in the capacity of a legitimate agent.

After providing tax guidance as to the mechanics of section 160 and discussing its conflicted jurisprudence, this article examines the Tax Court's decision in Brown v The Queen. It then concludes by offering some tax tips.

The Mechanics of Section 160 of the Income Tax Act

Section 160 applies if the following four conditions have been met:

• A property was transferred.
• 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:
• • the transferor's spouse or common-law partner (or a person who has since become the transferor's spouse or common-law partner);
    a person who was under 18 years of age; or
  • 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 goes bankrupt and receives a discharge from bankruptcy—thereby releasing him or her from the underlying tax debt—the recipient still remains liable to the CRA for the amount assessed under section 160 (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 given by the recipient for the transferred property. For example, a tax debtor owns a home (with no mortgage) worth $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 son's consideration.

Finally, subsection 160(3) governs how payments apply to discharge the joint tax liability. A payment by the taxpayer who inherited the tax liability under section 160 will reduce both taxpayers' tax debt—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. Payments by the original tax debtor don't affect the joint debt unless the original tax debtor has first paid off any tax debts exceeding the joint debt.

For example, say the original tax debtor owes $1 million in tax, and the joint debtor became jointly liable for $500,000 under section 160.

• Alternative 1: The joint debtor pays $500,000, and the original tax debtor pays nothing. In this case, the joint debtor extinguishes his liability under section 160, and the original tax debtor's liability is reduced by $500,000.
• Alternative 2: The original tax debtor pays $500,000, and the joint debtor pays nothing. In this case, the original tax debtor reduces her amount owing by $500,000, but the joint debtor's liability remains unchanged at $500,000.
• Alternative 3: The original tax debtor pays $750,000, and the joint debtor pays nothing. In this case, the original tax debtor 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—i.e., the tax debts not inherited by the transferee.

Conflicting Jurisprudence in Sympathetic Cases

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. In addition, section 160 doesn't contain a limitation period. So, even if several years have elapsed since the purported transfer, the Canada Revenue Agency can still assess you for derivative tax liability under section 160.

As a result, courts struggle when faced with sympathetic cases and have rendered seemingly inconsistent decisions. For instance, in LeBlanc v The Queen, 99 DTC 410 (TCC), a taxpayer's wife took over his financial affairs when he became very ill. The wife deposited the taxpayer's RRSP into their joint bank account and used the funds solely for her husband's finances. At the time, the husband owed tax to the Canada Revenue Agency. So, the CRA assessed the wife for derivative tax liability under section 160. The Tax Court of Canada, however, decided that section 160 didn't apply. The court reasoned that no transfer took place because the funds did not vest in the wife; she only dealt with the funds as her husband's agent.

But, in The Queen v Livingston, 2008 FCA 89, the Federal Court of Appeal decided that a transfer of funds did in fact result in derivative tax liability under section 160—even if the transferee had never personally used those funds. In Livingston, Ms. Davies, a tax debtor, deposited funds into the bank account of her friend, Ms. Livingston. Ms. Livingston never touched any of the funds that Ms. Davies had deposited. In fact, Ms. Livingston opened the account specifically for the Ms. Davies's use and gave Ms. Davies the sole debit card for that account. The Federal Court of Appeal held that Ms. Davies's deposits constituted transfers to Ms. Livingston because the bank account was solely under Ms. Livingston's name and thereby "permitted [Ms. Livingston] to withdraw those funds herself anytime." Yet this reasoning should extend to cases involving deposits into joint accounts—such as LeBlanc. After all, a joint bank account permits either of the joint holders to withdraw all funds at anytime.

The Issue of Consideration: Moral Obligation vs. Legal Obligation

As noted above, section 160 applies only if the recipient paid the transferor less than fair market value for the transferred property. In Livingston, Ms. Livingston's Canadian tax lawyer also argued that section 160 didn't apply because Ms. Livingston had given Ms. Davies fair-market-value consideration—namely, the permission to use Ms. Livingston's bank account.

The Federal Court of Appeal rejected this argument. The court found that the Ms. Livingston's permission stemmed from a moral obligation, not a legal one:

Nor am I convinced that the respondent's failure to seize the money constituted consideration for the moneys deposited. While forbearance—the act of refraining from enforcing a right, obligation, or debt—can act as consideration for a promise given in return [...], in my opinion there was no legal forbearance in this case. Indeed, contrary to the finding of the Tax Court Judge, there was no contract. Rather, it is my opinion that the respondent simply acted out of a sense of moral obligation to Ms. Davies. Such an action does not constitute a binding agreement. [Livingston, ibid., at para 29]

Given this finding, the court concluded that, by allowing the Ms. Davies to use her bank account at will, Ms. Livingston hadn't thereby provided fair-market-value consideration that would oust section 160.

Yet, although the Federal Court of Appeal shot down the argument, the court's reasoning indicated that, when faced with similar circumstances, a taxpayer could avoid derivative tax liability under section 160 by producing evidence of an enforceable contract. This reasoning planted the seed that would bear fruit in Brown v the Queen.

Brown v the Queen, 2020 TCC 45: Elaborating on Legal Obligation as Fair-Market-Value Consideration

The case involved Mrs. Tamara Brown, but the story begins with the plight of her husband, Mr. Gordon Levoy.

Mr. Levoy owned and operated an incorporated resort business in Collingwood, Ontario. For its reservations and promotional activities, the resort had a call centre. The call center didn't operate on a full-time basis. So, Mr. Levoy decided to rent it to others during off hours.

As luck would have it, Mr. Levoy ended up renting the call centre to fraudsters. The people who rented the call centre used it to sell fake credit-card insurance in the United States. Mr. Levoy claimed that he didn't know about the criminal activities. But because Mr. Levoy was the sole owner and operator of the resort, in 2002, Canadian and US authorities both laid criminal charges against him.

After charges were laid against Mr. Levoy, both he and his business underwent an audit by an external audit firm. The firm discovered unreported income and advised Mr. Levoy to file an application under the CRA's Voluntary Disclosures Program. He did so, but the VDP ultimately rejected his disclosure application. As a result, Mr. Levoy was reassessed for over $600,000 in tax, interest, and penalties relating to the 1997 through 2002 taxation years.

The criminal charges also caused Mr. Levoy's banks to close his bank accounts. Even after the charges were dropped in 2005, Mr. Levoy still couldn't open a bank account.

In 2005, Mr. Levoy's resort resumed operations using a revamped accounting and operating system, which included hiring an external payroll-services provider. The payroll-services provider would make source deductions and issue paycheques to the resort's employees, including Mr. Levoy.

Yet Mr. Levoy had nowhere to deposit his paycheques, and he couldn't conveniently pay his personal expenses. For no bank would allow him to open a bank account. To solve the bank-account problem, Mr. Levoy's accountant suggested that Mr. Levoy deposit his paycheques into his wife's bank account.

Mrs. Brown was initially reluctant, given her husband's recent issues with law enforcement. She eventually agreed after her husband's accountant told her that she faced no personal liability because a payroll-services provider would withhold source deductions on Mr. Levoy's salary. She only needed to deposit Mr. Levoy's paycheques and pay his credit-card bills with the deposited funds.

Mrs. Brown and Mr. Levoy both kept records of the amount of Mr. Levoy's salary that Mrs. Brown had deposited into her account and of the payments that Mrs. Brown made towards Mr. Levoy's credit-card bills. If, for a particular month, the amount of Mr. Levoy's deposited salary exceeded the amount of his credit-card bills, Mrs. Brown would roll over the excess and apply it to the following month's credit-card bill.

Mrs. Brown and Mr. Levoy continued this arrangement throughout 2006, 2007, and 2008. In total, Mrs. Brown had deposited over $150,000 of Mr. Levoy's salary into her bank account.

Because Mr. Levoy still owed over $600,000 in tax debt, in 2010, the Canada Revenue Agency assessed Mrs. Brown for derivative tax liability under section 160. Mrs. Brown's derivative tax liability equalled the over $150,000 of Mr. Levoy's salary that she had deposited into her bank account. (Ironically, a few years later, Mr. Levoy had been released from the underlying $600,000 tax debt when he paid $170,000 to the CRA in satisfaction of a bankruptcy proposal.)

Mrs. Brown disputed her derivative tax liability. The dispute eventually ended up in Tax Court. The Canadian tax lawyer for Mrs. Brown argued that section 160 didn't apply because she provided consideration that equaled the amount of Mr. Levoy's salary that she had deposited into her bank account. In support, Mrs. Brown pointed out that (1) she and Mr. Levoy had agreed that she would deposit his paycheques into her bank account and use the money so deposited to pay his credit card bills, (2) she had made a legally enforceable promise to pay out the money only on Mr. Levoy's direction and did not have any discretion on how Mr. Levoy's money was to be used, and (3) she did not use Mr. Levoy's money for any purpose other than paying his credit card bills, which in fact were paid.

The Tax Court decided in Mrs. Brown's favor, holding that section 160 didn't apply because Mrs. Brown had given fair-market-value consideration by agreeing to pay Mr. Levoy's creditors per his direction. In other words, she acted as her husband's agent. Moreover, the court found that Mrs. Brown's conduct stemmed from a legal obligation, not a moral one:

I am of the view that there was an enforceable contract between the Appellant and Mr. Levoy. The Appellant undertook to deposit Mr. Levoy's paycheques in her personal bank account. In return, she committed to pay Mr. Levoy credit card bills pursuant to his direction. The evidence established that Appellant could have been forced to pay Mr. Levoy's credit card bills if she had refused to pay. Mr. Levoy could have taken an action against the Appellant to enforce the agreement. [para 52]

The court's decision turned on Mrs. Brown's evidence—namely, credible testimony and meticulous records:

In this appeal, both the Appellant and Mr. Levoy testified. I do not have any reason to doubt their testimonies. They were credible witnesses who answered the questions asked at trial in a straightforward manner. [...] [T]he Appellant testified that she could be forced by her spouse, Mr. Levoy, to pay his credit cards. [paras 59-60]

The Appellant maintained detailed records of the funds that belonged to her spouse, namely the funds deposited, as well as the monthly payments she made on his behalf. Not only the documents were more than sufficient, but they also corroborated the testimonies of the Appellant and Mr. Levoy. [para 61]

As a result, Mrs. Brown avoided over $150,000 in derivative tax liability.

Pro Tax Tips – Assessments Under Section 160

If you transfer property to your friends or relatives in an attempt to keep assets away from CRA tax collectors, you expose them to CRA collections action.

If you allow a spouse, friend, or relative to use your bank account, and that person has tax debts, you risk exposure to derivative tax liability under section 160. The Brown case illustrates the importance of proving that you used none of the funds for your own benefit, and that you refrained from doing so because of a legal obligation. Our Canadian tax lawyers can assist you not only with deciding how best to prove the flow of funds but also with drafting the agreements that capture the legal obligations you accepted under the arrangement.

Likewise, if you plan on entering any transaction with a related party, 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 tax guidance on reducing the risk of an assessment under section 160.

If you're assessed for vicarious tax liability under section 160, you may challenge not only the merits of the assessment itself but also the correctness of the underlying tax debt—even if the original taxpayer never challenged the tax debt or did challenge the tax debt yet failed to lower the amount.

You have a limited amount of time to object to an assessment under section 160. If you fail to do so, you're personally stuck with the derivative tax liability. And you will remain liable even if the original tax debtor goes bankrupt.

The jurisprudence on an agent's liability under section 160 is still evolving. If you are assessed under section 160 because you obtained property or funds, and you might have been an agent, you should consult with a Canadian tax lawyer who thoroughly understands this area of law. Speak with one of our expert Canadian tax lawyers today to ensure that you deliver a strong, thorough, and cogent response to the CRA.