In technical interpretation 9704835 (CCH Window ¶5212), the CRA points out that the Income Tax Act provides for a rollover of goodwill at cost. The deceased’s estate cannot elect out of the rollover. As a result, the exemption cannot be used to increase the cost of goodwill for which the exemption might have otherwise been available during the deceased’s lifetime (eg farm quota).

The CRA states in the technical that it has referred the matter to the Department of Finance presumably for a possible legislative amendment. I’m sure Finance will be addressing the matter Real Soon Now.™

The employment contract is usually signed by the professional both in his or her personal capacity and on behalf of the PC as its President. Given that the professional signs in both capacities — and is really the directing mind of both persons involved — it seems like an odd practice, but the fact is that the CRA expects to see a written agreement. See Interpretation Bulletin IT-189R2 especially paragraph 1(j), which says the following:

[A] corporation is recognized as carrying on a professional practice if the activities of the corporation and its relationship to its employees and clients are similar to those ordinarily associated with a corporation carrying on a business. Such activities include … maintaining an employer-employee relationship between the corporation and the individual, with the services to be performed clearly set out in a dated, written agreement wherein specific provisions determine a reasonable salary for the services performed

See also CRA technical interpretation 2003-0030115 dated October 10, 2003, which summarizes the response to question 16 at the 2003 Table Ronde sur la Fiscalite Federale APFF.

This approach has been called “overly zealous” (see Colin Smith and John Loukidelis, “Professional Incorporations”, a paper presented at the Ontario Bar Association seminar “More Tax Issues You Cannot Afford to Miss”, Toronto, Ontario, November 22, 2005). I expect that a tax court would not insist on a written agreement as required by the CRA (unless, perhaps, the professional is purporting to assign amounts received to the PC eg where a doctor assigns OHIP billings to the PC). The fact remains, however, that auditors expect to see one (or so I’m told), and so, to avoid wasting time on a debate on the subject, we prepare the agreement.

In June, 2006, a father purported to transfer real property to his daughter for no consideration at a time when the father owed tax. The daughter knew nothing about the transfer of the property. She only found out about it when she visited her father in December, 2008, and he showed her an assessment from CRA in respect of the transfer. The daughter sought legal advice and, in February, 2009, she transferred the property back to the father.

Justice admitted that the daughter knew nothing about the transfer, but it argued that her lack of knowledge did not prevent the application of section 160. The court disagreed:

The Federal Court of Appeal [in Biderman v. The Queen, 2000 CanLII 14987, 2000 DTC 6149] makes it clear that failed testamentary gifts are not caught by section 160 and that the section does not alter the common law. There is nothing in section 160 that indicates that different rules or potential alteration of the common law applies to different types of transfers such that its application to inter-vivos gift should be the same as to testamentary gifts. A transfer of an inter-vivos gift must be a completed transfer, not a failed or void transfer; intent and delivery by and of one party alone is insufficient. In my opinion, section 160 should not be read as to apply to a failed inter-vivos gift. If a gift lacks any of the three requirements, it is void ab initio. In the case at bar, what is asserted is that there was no knowledge or acceptance of the gift and once the gift was known, it was repudiated within an acceptable time by transferring back the property to her father. In my opinion, this transfer back constitutes, in these circumstances, a valid disclaimer and, as such, there was no transfer, direct or indirect of the property; hence paragraph 160(1)(c) cannot apply to the Appellant. The word “dealing” in subsection 160(c) of the Act connotes actual action and not a state of relationship. In my view, that provision will not apply unless there is knowledge on the part of the transferee. Therefore, the transfer in issue herein is not caught by section 160.

Our deeds of gift contain language like that used in the instrument by which Mr McNamee Sr gifted Common Shares to his son as part of his freeze. The language used was as follows:

I hereby direct that the whole of the Property gifted to each Donee, the income arising therefrom, any appreciation in the value thereof, and any property acquired in substitution therefor shall not fall into any community of property which may exist between the Donnee and his spouse, and shall not form part of the net family property of the Donee for any purpose or purposes under the Family Law Act, R.S.O. 1990, c. F.3 and any amendment thereto or any successor legislation thereto, and is given to the Donee on the condition that it shall remain his separate property, free from the control of his spouse. This direction shall apply not only to the Family Law Act, but also to the laws of any other jurisdiction dealing with the distribution of property in the event of death or marriage breakdown.

The McNamee trial judge (McNamee v McNamee, 2010 ONSC 674) held that the father’s transfer of shares to his son was not a gift that was excluded from the son’s net family property because

a) The transfer was not a gratuitous transfer but was a transfer for consideration;
b) Mr. McNamee Sr. did not intend to gift the shares;
c) Mr. McNamee Sr. did not divest himself of all power or control over the shares; and,
d) The appellant did not accept the gift.

The Court of Appeal rejected each of these propositions and found that the transfer of shares was by way of a gift. The trial judge, for example, had held that Mr McNamee Sr hadn’t made a gift because he received a benefit in the form of accomplishing his estate planning goals. The Court of Appeal responded (at ¶ 31) that consideration or a benefit, to vitiate a gift, must flow from the donee (cf Maréchaux). The trial judge had found that Mr McNamee Jr hadn’t accepted the gift because he did not understand the transactions relating to it. The Court of Appeal disagreed:

Here, contrary to the trial judge’s view, the appellant understood the essential nature of the transaction – he had received shares in the company and had paid nothing for them – and he willingly accepted title to those shares. In the circumstances of this case, we do not think the appellant’s lack of knowledge of the terms and conditions attached to the gift is particularly germane.

Imagine if every client needed to understand all aspect of a tax-driven reorganization before gifts made in connection with it could become effective!

The Court of Appeal rejected the trial judge’s approach, which would seem to add some certainty about when a gift will be excluded for family law purposes. But the decision also highlights the other avenues of attack that remain for the spouse who has been shut out. The Court ordered a new trial “on the issue of unjust enrichment and constructive trust”. Under the Family Law Act, a gift can be excluded from the value of a spouse’s net family property, but the logically prior question is who owns what for the purposes of computing the net family property values. In McNamee, the son appeared to own the Common Shares as a result of the gift from his father, but the doctrine of constructive trust might be found to apply to give Mrs McNamee a beneficial ownership interest in the shares. If the judge at the new trial determines that the doctrine applies, then Mr McNamee might end up splitting the value of the shares with Mrs McNamee after all.

The following are the highlights of the case.

1. For the purposes of the due diligence defence to a director-liability assessment for both source deductions and GST/HST assessments, the objective standard set out in Peoples Department Stores Inc.(Trustee of) v Wise, 2004 SCC 68, [2004] 3 S.C.R. 461, has replaced the so-called “objective subjective” test set out in Soper v R, 1997 CanLII 6352 (FCA), [1998] 1 F.C. 124.

2. The consequences of this “new” standard, according to the FCA, are as follows (and are worth quoting at length):

[38] This objective standard has set aside the common law principle that a director’s management of a corporation is to be judged according to his own personal skills, knowledge, abilities and capacities: Peoples Department Stores at paras. 59 to 62. To say that the standard is objective makes it clear that the factual aspects of the circumstances surrounding the actions of the director are important as opposed to the subjective motivations of the directors: Peoples Department Stores at para. 63. The emergence of stricter standards puts pressure on corporations to improve the quality of board decisions through the establishment of good corporate governance rules: Peoples Department Stores at para. 64. Stricter standards also discourage the appointment of inactive directors chosen for show or who fail to discharge their duties as director by leaving decisions to the active directors. Consequently, a person who is appointed as a director must carry out the duties of that function on an active basis and will not be allowed to defend a claim for malfeasance in the discharge of his or her duties by relying on his or her own inaction: Kevin P. McGuinness, Canadian Business Corporations Law, 2nd ed. (Markham, Ontario: LexisNexis Canada, 2007) at 11.9.

[39] An objective standard does not however entail that the particular circumstances of a director are to be ignored. These circumstances must be taken into account, but must be considered against an objective “reasonably prudent person” standard. As noted in Peoples Department Stores at paragraph 62:

The statutory duty of care in s. 122(1)(b) of the CBCA emulates but does not replicate the language proposed by the Dickerson Report. The main difference is that the enacted version includes the words “in comparable circumstances”, which modifies the statutory standard by requiring the context in which a given decision was made to be taken into account. This is not the introduction of a subjective element relating to the competence of the director, but rather the introduction of a contextual element into the statutory standard of care. It is clear that s. 122(1)(b) requires more of directors and officers than the traditional common law duty of care outlined in, for example, Re City Equitable Fire Insurance, supra [[1925] 1 Ch. 407].

[40] The focus of the inquiry under subsections 227.1(3) of the Income Tax Act and 323(3) of the Excise Tax Act will however be different than that under 122(1)(b) of the CBCA, since the former require that the director’s duty of care, diligence and skill be exercised to prevent failures to remit. In order to rely on these defences, a director must thus establish that he turned his attention to the required remittances and that he exercised his duty of care, diligence and skill with a view to preventing a failure by the corporation to remit the concerned amounts.

3. The standards of care required with respect to unremitted GST/HST and unremitted source deductions do not differ. All of the amounts collected by a corporation for these purposes are paid by third parties (customers and employees) to satisfy their liabilities under the various statutes. All of these amounts are deemed to be held in trust by the statutes. In particular, “the liability of the directors under subsection 227.1(1) [of the ITA] is not conditional on the existence of sufficient cash in the corporation to pay the remittances of employee source deductions, quite the contrary.” [¶ 45]

4. The court reiterated the following (without overruling R v McKinnon, 2000 CanLII 16269 (FCA), [2001] 2 FC 203 (C.A) 2000 DTC 6593 sub nom. Worrell v R [2001] 1 CTC 79):

[49] The traditional approach has been that a director’s duty is to prevent the failure to remit, not to condone it in the hope that matters can be rectified subsequently: Canada v. Corsano, 1999 CanLII 9297 (CAF), [1999] 3 F.C. 173 (C.A.) at para. 35, Ruffo v. Canada, 2000 D.T.C. 6317, 2000 CanLII 15199 (FCA), [2000] 4 C.T.C. 39 (F.C.A.). … The defence under subsection 227.1(3) of the Income Tax Act and under subsection 323(3) of the Excise Tax Act should not be used to encourage such failures by allowing a due diligence defence for directors who finance the activities of their corporation with Crown monies on the expectation that the failures to remit could eventually be cured.

5. “A director of a corporation cannot justify a defence under the terms of subsection 227.1(3) of the Income Tax Act where he condones the continued operation of the corporation by diverting employee source deductions to other purposes.” (¶ 56)

In a previous post, I pointed out that naive but well-meaning family members who become directors of corporations to help out the entrepreneur in the family might find a sympathetic hearing at the Tax Court if they were assessed for unremitted source deductions or GST/HST. Query whether that is still true in light of Buckingham. All the more reason, then, to exercise caution in making a spouse, sibling or parent a director because “that’s what the bank wants” or whatever.

[17] Mr. Jeannotte [the taxpayer representative] stated that the law was not fair and asked that the Court interpret section 120.4 in a manner consistent with his argument. However, the Court must interpret the section as it finds it. As stated by Rothstein J.A., as he then was, in Chaya v Canada[2004 FCA 327] at paragraph 4:

[4] The applicant says that the law is unfair and he asks the Court to make an exception for him. However the Court does not have that power. The Court must take the statute as it finds it. It is not open to the Court to make exceptions to statutory provisions on the grounds of fairness or equity. If the applicant considers the law unfair, his remedy is with Parliament, not with the Court.

[18] The appeal is dismissed.