05 July 2013

Another reason to keep your affairs in order

The Globe and Mail recently published an article relating to the long-arm powers available to the Canada Revenue Agency to collect its debts. In this case, it concerns the transfer of property in non-arm's-length transactions where the transferor has outstanding tax liability, which, under s. 160 of the Income Tax Act, will attract liability in the hands of the recipient.

S. 160's reach is quite broad:

  • it captures the transfer of property, either directly or indirectly, by means of a trust or by any other means whatever, to
  • a person's spouse or common-law partner, anyone under the age of 18, or anyone not being dealt with at arm's length,
  • resulting (before taking into account the effect of the income attribution rules in the Act) in both the transferor and transferee being jointly and severally liable for the amount (in excess of the fair market value of any consideration given) in order to satisfy the outstanding tax liability in question.
What constitutes a "transfer of property?" It can be:
  • a gift or bequest,
  • a deposit into the transferee's bank account,
  • releasing an interest in a joint bank account or a joint tenancy to the other titleholder,
  • making payments on another person's mortgage,
  • a tax-debtor corporation issuing dividends to related shareholders who are in a position to control the corporation, or
  • a series of transactions from one non-arm's-length person to another (in which case the joint and several liability applies to all parties!)
but it does not include payments made under a court order or separation agreement (by virtue of s. 160(4)).

Two recent cases at the Federal Court of Appeal help to explain s. 160's scope:
  • Canada v. Livingston, 2008 FCA 89 (CanLII), [2008] 3 CTC 230(which addresses the key criteria for s. 160 assessments)
  • Yates v. Canada, 2009 FCA 50, [2010] 1 FCR 436, [2009] 3 CTC 183(which calls for strict interpretation of the section)
There is no limitation period by which such an assessment can become statute-barred, and the effects do not end there:
  • s. 325 of the Excise Tax Act provides that, where there is an amount by which such an undervalue transaction exceeds the liability that can be assessed under the ITA, it is available for similar assessments to satisfy any outstanding liability for GST/HST.
  • s. 96 of the Bankruptcy and Insolvency Act provides similar recovery powers in the event of certain undervalue transactions occurring prior to bankruptcy (within the previous year, or the previous five years if the transaction was not at arm's length) where the debtor was insolvent at the time of the transfer or was rendered insolvent by it, or the debtor intended to defraud, defeat or delay a creditor.
I have published several posts recently on the need to prove a genuine business case before undertaking transactions that are not at arm's length. This is an addition to what should be kept in mind.

You always need a business case...

Many readers in the business world will know of instances where corporations they were working for, or dealing with, have indulged in oppressive or abusive behaviour. The larger ones are more likely to have internal procedures or protocols to mitigate such effects, but the SMEs have tended to be more reckless.

If you're dealing with an American corporation, the rules will more than likely operate in their favour. If the corporation has been established in Canada, you can fight back through the oppression remedy available under the various corporation laws. This is an innovation that has developed in many countries of the Commonwealth, but it has attained significant breadth of scope here.

What types of behaviour can be addressed under an oppression claim? Basically, it can be potentially used by any stakeholder to deal with any type of unfair conduct by a corporation, and the definition is "wide enough to cover oppression by anyone who is taking part in the conduct of the affairs of the company whether de facto or de jure" (as noted in the English case Re HR Harmer Ltd, [1959] 1 WLR 62 at 75,  by Jenkins LJ). In Canada, stakeholders include:

  • a current or former registered security holder,
  • a current or former director or officer,
  • the Director appointed under the CBCA, or 
  • "any other person who, in the discretion of a court, is a proper person to make an application under this Part" (which can cover creditors, debtors or employees)

The types of behaviour that can be addressed, and the scope of the remedies available, are breathtaking:

  • Claims can extend to an affiliate not incorporated under the same Act 
  • It has been used to enforce unpaid judgments against the corporation's directors, where the corporation had been subject to asset stripping 
  • It has also been used in conjunction with other remedies — including the threatened winding up of a company by the court — in order to resolve shareholder disputes in closely held companies. 
  • The Crown has employed the oppression remedy in its status as a creditor under the Income Tax Act, in order to set aside dividend payments that rendered a corporation unable to pay its tax liability. 
  • Where a company has made excessive salary payments to a controlliing shareholder, a judgment creditor has been permitted to be a complainant in order to recover the excess amounts. 
  • A wrongfully dismissed employee can make a claim in order to thwart a corporation from conducting asset stripping in order to make itself judgment proof. 
What can a company do to protect itself against such claims? The Supreme Court of Canada, in BCE Inc. v. 1976 Debentureholders, stated that, where conflicting interests arise, it falls to the directors of the corporation to resolve them in accordance with their fiduciary duty to act in the best interests of the corporation. There are no absolute rules and no principle that one set of interests should prevail over another. Under the business judgment rule, deference should be accorded to the business decisions of directors acting in good faith in performing the functions they were elected to perform.

Therefore, the directors really need to do their job properly in looking after the corporation's interests first, being aware that evasion of liabilities and condoning disputes among shareholders and other key players do not make for good business, and documenting the business case for undertaking any fundamental changes to their corporate and cost structures. Well-written business agreements will also go a long way to address key concerns.