CRA goes after enterprise proprietor who gave himself dividends

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Many retail buyers are definitely aware of the idea of dividend revenue, having obtained it both by way of direct possession of publicly traded shares or, not directly, via the possession of mutual funds that stream dividends out to them.

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

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However for those who’re a enterprise proprietor who owns an included enterprise, together with knowledgeable company, dividends are typically regarded as a type of remuneration. Take into account a enterprise proprietor who owns 100 per cent of the shares of their company. To extract funds from their enterprise to dwell 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 of remuneration, which might have extreme implications for a enterprise proprietor, as one Delta, B.C., taxpayer lately discovered. The taxpayer, a chartered skilled accountant and licensed insolvency trustee, was in Tax Courtroom in September to problem a Canada Income Company evaluation below part 160 of the Revenue Tax Act.

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Part 160, also called the “joint legal responsibility rule,” offers the CRA the ability to carry a person accountable 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, sometimes blood family members, 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 have to be met for the CRA to efficiently win a joint-liability evaluation: there will need to 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 ample consideration paid by the transferee to the transferor; and the transferor will need to have had an excellent tax legal responsibility on the time of the switch.

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Within the current case, the taxpayer was reassessed in 2017 below 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 have been declared and approved 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 practically $110,000, representing the whole federal and provincial tax owing, plus accrued curiosity. The problem to be determined by the Tax Courtroom was whether or not the taxpayer needs to be held collectively and severally accountable 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 have been in consideration for providers he offered to the company as a person licensed insolvency trustee. He maintained the dividends have been paid to him personally to retain his providers. “In as we speak’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 have been clearly met, however the taxpayer and the CRA disagreed as as to whether or not the taxpayer offered consideration (his providers) 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 providers he offered to the company have been the consideration he offered to the company in return for the dividends. However this argument has failed prior to now because of the inherent nature of dividends.

The Tax Courtroom referred to a seminal 1998 choice of the Supreme Courtroom of Canada that decided a dividend is said to shareholding and to not every other consideration the shareholder might need offered.

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“A dividend is a cost which is said by means of entitlement to at least one’s capital or share curiosity within the company and to not every other consideration,” the Supreme Courtroom 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 Courtroom 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 basic 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 have been akin to cost for his providers. However the Tax Courtroom 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 depend 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 accountable for the tax owing below part 160 of the Revenue Tax Act.

Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Property Planning with CIBC Non-public Wealth in Toronto. [email protected]

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