Two recent Tax Court of Canada decisions address disputes arising from the transfer of property from a tax debtor to a non-arm’s length party. The first decision released was Harvey v. The Queen, 2018 TCC 67, which dealt with an appeal of an assessment under section 325 of the Excise Tax Act (the “ETA”). The other decision was Ashworth v. The Queen, 2018 TCC 76, an oral judgment dealing with an assessment under section 160 of the Income Tax Act (the “ITA”). These decisions illustrate the importance of credible valuations and clear documentation to avoid problems when there is a transfer from a tax debtor.
Subsection 160(1) of the ITA and subsection 325(1) of the ETA are similar, though not identical. They focus on ensuring that tax debts are paid by preventing the ability of a tax debtor to transfer property to avoid paying the tax debt. Both address direct or indirect transfers, and transfers through a trust. They also address transactions with the same types of transferees. This includes anyone not dealing at arm's length. Spouses and common law partners as well as individuals under 18 are specifically included. In both cases the transferor and transferee become jointly and severally, or solidarily, liable for the tax debt, to the extent the value of the property transferred by the tax debtor exceeds the value of the consideration given in return. The difference in value is a key part in calculating liability under these provisions. This was the source of the dispute in both Ashworth and Harvey.
In Ashworth, the property in question was a half-interest in the family home. The tax debtor was a husband who transferred his half-interest to his wife, who already held the other half-interest. The Minister of National Revenue (the “Minister”) argued that there was a $59,682 shortfall in consideration. In this case, the dispute was whether the full amount of certain payments should be included as consideration. The transferee wife had borrowed money from a bank to pay off a loan owing by the transferor husband's company. That loan was secured by a collateral mortgage on the house, which was removed as a consequence of the loan repayment, so the wife argued this was partial consideration she paid for the half-interest. She also argued certain payments she made to her credit card were for the benefit of the husband’s company and constituted consideration.
The Minister argued that only half of the amount paid to remove the collateral mortgage was consideration since each of the husband and wife was responsible for half of the collateral mortgage when each was a half-owner. The court disagreed with the Minister and found the whole amount of the payment to be consideration. It reasoned that the wife knew that the company and her husband were in financial trouble. The husband was the sole shareholder in the company. The whole point of the transfer was to protect the house from creditors by removing the collateral mortgage. There was also enough equity in the home for the whole collateral mortgage to have come out of the husband’s portion of the equity as security. This was seen as the most logical reason for the transaction. As such, the whole amount of the loan repayment, which removed the collateral mortgage, was consideration for purposes of section 160 of the ITA.
The court found the wife’s argument that payments for credit card purchases, supposedly made on behalf of the company, were consideration was less convincing. This was largely due to a lack of supporting evidence, i.e., lack of the credit card statements. In the end, there was still a shortfall in consideration and liability for the wife transferee but it was significantly reduced. The court determined that the shortfall in consideration was only $6,730.
In Harvey, there was a transfer of a residential building by a tax debtor to his spouse’s father to which section 325 of the ETA applied. The dispute was about the fair market value of the building. The transferee father-in-law claimed that he wanted a retirement property and to rent out the basement. This was not seen by the court as particularly credible since his daughter and the tax debtor “continued to frequent the place”[1] and the basement was never actually rented out by the father. Therefore, the court found it had to rely on expert testimony to determine the building’s value.
There were two expert witnesses who testified about the building’s fair market value—one for the tax debtor and one for the Minister. Both looked at cost and comparison methods for valuing the property. They agreed the comparison method was preferable in this situation, though each expert’s approach differed. One difference was whether comparisons should be based on categories and structural features or the type of property such as detached or duplex. Another difference was whether the end comparison was based on the most similar property or an average. Adjusting for differences between a detached property and a duplex was seen by the court as more complex. The court preferred the approach of the Minister’s expert based on type of property because it held that the quality of a comparable is measured by the fewer number of adjustments required to be made for purposes of comparison. However, there were still some adjustments needed with that expert’s approach. The comparables were sold furnished and the property at issue was sold unfurnished so adjustments were made to reflect that. The approach that was accepted was based on a comparable property where the deed of sale had a price breakdown including furniture. Renovations were needed so adjustments were made to account for that cost as well. A contractor’s bid was used to estimate the renovation costs. The court noted that the Minister’s expert questioned the bid and made corrections to estimate the value of the work. The tax debtor’s expert had accepted the bid without pointing out errors it contained. In the end, the court accepted the approach taken by the Minister’s expert and held the value of the property was $271,000. There was a discrepancy of $64,000 from the father-in-law’s claimed value.
As these cases show, the value of what was exchanged is an important issue regarding transfers involving a tax debtor and a non-arm’s length party. When the consideration or property given is not money, clear documentation of value is important and expert valuation should be considered carefully. It is also helpful to have clear purchase and sale documentation and clear directions regarding any payments. The absence of such documentation was noted in the Ashworth decision. These documents can help establish that certain items were intended to be consideration.