CRA goes after enterprise proprietor who gave himself dividends

Jamie Golombek: A dividend is not legally thought-about remuneration, which might have extreme implications

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Many retail traders are actually acquainted with the idea of dividend revenue, having obtained it both through direct possession of publicly traded shares or, not directly, by way of the possession of mutual funds that circulation 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 somewhat than retain for its personal use.

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However if you happen to’re a enterprise proprietor who owns an included enterprise, together with knowledgeable company, dividends are generally 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 stay on, they’ll select to pay themselves a wage or, as the only shareholder, have the company pay them a dividend.

However a dividend is just not legally thought-about remuneration, which might have extreme implications for a enterprise proprietor, as one Delta, B.C., taxpayer just lately discovered. 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 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 chargeable 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 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 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.

The Canada Revenue Agency homepage.
The Canada Income Company homepage. Photograph by Graham Hughes/The Canadian Press

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 needs to be held collectively and severally chargeable for the $110,000 of tax owed by the company pursuant to part 160.

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In courtroom, the taxpayer argued the dividends paid to him had been in consideration for companies he supplied to the company as a person licensed insolvency trustee. He maintained the dividends had been paid to him personally to retain his companies. “In in the present day’s enterprise world, dividends are a legit 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 whether or not the taxpayer supplied consideration (his companies) for the property (the dividends) transferred to him by the company and, if that’s the case, whether or not the truthful market worth of that consideration exceeded the truthful market worth of the property transferred to him.

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The taxpayer mentioned the skilled companies he supplied to the company had been the consideration he supplied to the company in return for the dividends. However this argument has failed previously as a result of inherent nature of dividends.

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

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“A dividend is a fee which is said 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 basic precept of company legislation {that a} dividend is a return on capital which attaches to a share, and is on no account 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 decide 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 on the conduct of a given shareholder.”

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

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

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