December 8, 2022

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CRA goes after enterprise proprietor who gave himself dividends

CRA goes after enterprise proprietor who gave himself dividends

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

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Many retail buyers are actually conversant in the idea of dividend earnings, having acquired it both through direct possession of publicly traded shares or, not directly, by the possession of mutual funds that move dividends out to them.

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In these instances, dividends signify the investor’s share of company after-tax earnings {that a} company has determined to distribute to its shareholders slightly than retain for its personal use.

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However should you’re a enterprise proprietor who owns an integrated enterprise, together with an expert company, dividends are typically considered a type of remuneration. Contemplate 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 shareholder, have the company pay them a dividend.

However a dividend shouldn’t be legally thought of remuneration, which might have extreme implications for a enterprise proprietor, as one Delta, B.C., taxpayer not too long ago 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 Earnings Tax Act.

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Part 160, also called the “joint legal responsibility rule,” provides the CRA the facility to carry a person responsible 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 kin, 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 should 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 satisfactory consideration paid by the transferee to the transferor; and the transferor should have had an excellent tax legal responsibility on the time of the switch.

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Within the latest 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.

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

On the time of the switch, the company had a tax legal responsibility excellent of practically $110,000, representing the full federal and provincial tax owing, plus accrued curiosity. The difficulty to be determined by the Tax Courtroom was whether or not the taxpayer needs to be held collectively and severally responsible 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 have been in consideration for companies he supplied to the company as a person licensed insolvency trustee. He maintained the dividends have been paid to him personally to retain his companies. “In in the present day’s enterprise world, dividends are a respectable 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 if 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 stated the skilled companies he supplied to the company have 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 Courtroom referred to a seminal 1998 choice of the Supreme Courtroom of Canada that decided a dividend is expounded to shareholding and to not another consideration the shareholder might need supplied.

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“A dividend is a cost which is expounded by the use of entitlement to 1’s capital or share curiosity within the company and to not another consideration,” the Supreme Courtroom wrote. “Thus, the quantum of 1’s contribution to an organization, and any dividends acquired from that company, are mutually impartial 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 acquired 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 by no means depending on the conduct of a specific shareholder.”

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The taxpayer additionally tried to argue that he reported the dividends on his private earnings tax return and paid taxes on them, thus the dividends have been akin to cost for his companies. However the Tax Courtroom choose disagreed, concluding the “declaration of a dividend is, in company legislation, an allocation of an organization’s undistributed earnings 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 choose discovered the taxpayer to be collectively and severally responsible for the tax owing below part 160 of the Earnings 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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