The Gift That Keeps on Taking: The Tax Trap in Asset Transfers

Every professional has encountered it: a client eager to “sell” a property to a spouse, child, or business partner for $1.00—often with the goal of shielding assets from creditors, including the Canada Revenue Agency (CRA). Whether a transfer is framed as a nominal sale or it is actually a real, and heartfelt gift, these transfers can trigger serious tax consequences under Section 160 of the Income Tax Act.

If the transferor has outstanding tax debts, the recipient may become jointly and severally liable for those amounts, regardless of their awareness or intent. This memo unpacks the mechanics of Section 160, the risks of informal asset transfers, and how a well-meaning gesture can become a long-term financial burden.

Section 160 of the Income Tax Act is arguably one of the most powerful collection tools available to the Canada Revenue Agency (CRA).

If:

1. A taxpayer transfers property to a spouse, a minor, or another person with whom they do not deal at arm’s length; 

2. The transferee does not pay fair market value consideration for the property; and 

3. The transferor has a tax liability for the year of transfer or any prior year, then the transferee will be liable for some or all of the transferor’s outstanding tax liability.

The transferee’s liability will be the lesser of the transferor’s liability and the shortfall between the fair market value and the consideration paid. For example, if I owe the CRA $50,000 for 2024, and in 2025 I transfer property worth $20,000 to my child for $10,000, my child’s liability will be limited to the $10,000 shortfall. If my tax liability had been only $7,000, my child’s liability would not exceed that amount.

The transferee’s liability does not depend on knowledge or intention. The transferee may have no idea that I owe taxes — and I may not know either. In fact, the CRA may believe, at the time, that I have no outstanding tax liabilities. If I review my CRA file and no outstanding liability is shown, there is always a risk that CRA could reassess years later. If I transfer property to my son today, when everyone believes that there is no tax debt, and three years from now CRA re-assesses me in respect of 2024 and establishes that there is a liability outstanding, Section 160 will impose liability on my son, even though the transfer was made in good faith and without knowledge of any tax debt. The tax liability also includes any capital gains triggered by the disposition of the property.

Normal tax liabilities must be assessed within three or four years. Some tax debts, like a director’s liability for unpaid source deductions, or HST, expire after 2 years from the date of the resignation of the director. BUT there is no time limit on CRA’s ability to assess the transferee. The subsequent bankruptcy of the transferor, which eliminates their own liability, does not reduce the liability of the transferee.

Compensation Planning

In today’s world, owner-managers face the decision between salary and dividends each year. Tax professionals confirm that this discussion is a routine part of annual compensation planning. It is time for the CRA to recognize more fully that dividends are part of the owner-manager’s compensation.

There are various reasons that a business owner might choose dividends instead of salary

Dividends vs. Salary – Everyday Planning

Salary (or Bonus):

• Deductible to the corporation.

• Generates RRSP contribution room.

• Requires CPP contributions.

• Subject to withholding tax.

Dividends:

• Paid from after-tax income.

• Do not create RRSP contribution room.

• Not subject to CPP or EI.

• Generate dividend refunds from taxes paid on investment income

Every tax planning discussion should revisit this choice, factoring in personal and corporate tax rates, RRSP strategy, cash flow needs, and long-term planning.

CPP Contributions After Age 65 – No Automatic Exemption

If you are over 65 and receive a salary, you may still have to contribute to CPP unless you file Form CPT30 – Election to Stop Contributing to the Canada Pension Plan with your employer and CRA. Dividends, however, do not attract CPP contributions. This is another reason owner-managers may choose dividends over salary.

There is judicial authority to support a Section 160 assessment against the recipient of a dividend from a non-arm’s length company if the company had outstanding tax liabilities. Courts have confirmed that dividends are considered transfers of property without consideration.

We have seen some movement on the issue of dividends as compensation.

Supreme Court of Canada – McClurg Judgment

In McClurg, a 1990 decision of the Supreme Court of Canada, Chief Justice Dickson drew a distinction between dividends paid to non-arm’s length shareholders who made no contribution to the company and those paid where a legitimate contribution was made.

In view of the nearly universal view of dividends as (potentially) being part of an owner-managers compensation, and the (slight) movement found in CEBA and McClurg, it is time that the Government re-thinks the issue. 

CEBA Loans – Dividends Counted as Compensation

During COVID-19, the CEBA program was expanded to include family-owned corporations that compensated employees through dividends. This recognized dividends as a legitimate form of shareholder-employee compensation. It raises an important question: if dividends can qualify as compensation for CEBA purposes, why are they not recognized as compensation for the purposes of Section 160?

Tax on Split Income (TOSI)

In 2017, the Government amended the TOSI rules, in an effort to stop the splitting of income received from private, family companies. The TOSI rules now draw a distinction between a passive shareholder and a working shareholder for the purposes of determining tax on dividends paid. Clearly there is an element of remuneration for a working shareholder in terms of a lower rate of tax on dividends received.

Final Thoughts

This newsletter highlights that tax planning is never static. Each year’s review should reconsider how you pay yourself, the mix of salary, dividends, or other strategies, and the impact of legislative changes.

In any contemplated transfer of property, both the transferor and the transferee must seek sound tax advice to avoid costly unintended liabilities.

As the summer is, inevitably, reaching an end, and a Federal Budget is beginning to loom large, it is time to reconsider the basics of our personal and corporate tax positions.

As always, I would be happy to consult with your other advisors to ensure that your tax position is sound, defensible, and ready for any scrutiny.