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Most owner-managers think of the corporation as a wall. The company owes the tax; the company pays the tax; the shareholders are a step removed from all of it. That is usually how it works.

Section 160 of the Income Tax Act is the provision that removes the wall.

In Schonberger v. The King, 2024 TCC 82, two spouses who owned a construction company fifty-fifty found out what that means in practice. Over four years they had each taken $399,250 out of the company as dividends. Neither had ever drawn a salary. On October 18, 2017, the Canada Revenue Agency assessed each of them personally for $245,398, the company’s unpaid corporate debt.

They appealed. Justice Gagnon dismissed both appeals, with one set of costs.

Here is how it happened, and what it means for how you pay yourself out of your own corporation.

The facts

The company was Graycove Developments Inc., with a February 28 year end. Each spouse held 50 percent of the shares, and the two of them were the only officers and directors.

Across the company’s 2010, 2011, 2012 and 2013 financial years, the company declared and paid each shareholder dividends as follows:

The pattern behind those numbers is one most CPAs will recognize on sight. In the owner’s own words at trial, he did not take a salary or a cheque. He took draws as he needed money to live, and at the end of the year the bookkeeper put the figure together and the accountant allocated it to him as a dividend.

Nobody was on payroll.

The filing history matters as much as the dividends. The financial statements for all four years, 2010 through 2013, were finalized at roughly the same time, around September 10 to 13, 2013. The corresponding income tax returns went in over the following weeks and were assessed on October 8, 2013. So the 2010 statements were prepared more than three years after that year end, and the owner testified that he did not know why.

The company later filed a return for its year ending February 28, 2014 showing a loss. That return was filed after January 5, 2016. The 2014 loss was carried back to 2011, 2012 and 2013, reducing Part I tax to nil in 2011 and 2012 and to $5,884 in 2013, with provincial tax reduced to nil in 2011 and 2012 and to $2,407 in 2013.

What remained after all of that was the debt on which the spouses were assessed:

Three things in that table deserve a second look.

First, 2010 carries almost the entire balance.

Second, of the $245,398.18 total, only $128,078.62 is tax. The rest, more than $117,000, is penalty and interest, and the assessments against the spouses included interest accrued on the corporate assessments right up to October 18, 2017. Delay is not neutral. It compounds.

Third, and this is the one most owner-managers miss: look at the 2011 line. Tax of $0.00, and yet $13,633.13 still owing. The loss carryback wiped out the Part I tax for that year and the liability survived anyway, because penalties and interest had already accrued on the original amounts. A carryback is not a reset. It reduces the tax it reaches and leaves the rest standing, and the balance that remains is fully available to support a section 160 assessment.

How section 160 works

Section 160 exists to stop a taxpayer from moving assets beyond the reach of CRA collections. It does not require any intent to defeat the tax collector, and that is the part owner-managers consistently underestimate. It is a mechanical test.

Where a person transfers property to a spouse or common-law partner, to someone under 18, or to a person with whom they are not dealing at arm’s length, the transferee and transferor become jointly and severally liable for an amount equal to the lesser of:

1. the fair market value of the property transferred, less the fair market value of any consideration given for it; and
2. the total of all amounts the transferor is liable to pay under the Act in or in respect of the taxation year of the transfer or any preceding taxation year.

The exposure is capped twice over. You cannot be assessed for more than you received, and you cannot be assessed for more than the transferor actually owed. But within those caps, the liability attaches. Here the dividends of $399,250 exceeded the corporate debt of $245,398, so the debt was the binding cap.

Subsection 160(2) allows the Minister to assess at any time. There is no reassessment window to run out. That is why an assessment can land in 2017 for a dividend paid in 2010.

The Court identified subsection 160(1) as the sole relevant provision, and found three of its elements effectively uncontested. The dividends were transfers of property, and on the authority of Algoa Trust a cash dividend is a transfer of property without consideration for section 160 purposes. The company had liabilities under the Act. And because the appellants were spouses and the sole shareholders, they were related persons under section 251 and therefore deemed not to deal at arm’s length with the company.

That left one live question on the statutory test, plus one question about the size of the underlying debt.

Argument one: the corporate tax bill was wrong

The appellants argued that the corporate reassessments were too high, and that on the economic reality of the income in the years concerned there should not have been a liability to pass down at all.

The Court accepted that they were entitled to run that argument. Following the Federal Court of Appeal in Canada v. 594710 British Columbia Ltd., a person assessed under section 160 can challenge the underlying tax debt of the transferor, and the corporation’s own action or inaction does not shut that door. The Court added a practical qualification: the way to challenge the transferor’s liability is to challenge the underlying assessment that reflects it.

The question was who had to prove what.

The burden of proof

Relying on Manna v. The Queen, 2019 TCC 70, and through it Mignardi v. The Queen, the Court restated the rule. A taxpayer bears the onus of establishing that an assessment is incorrect. The onus shifts to the Minister only where the facts concerning the underlying tax debt are exclusively or peculiarly within the Minister’s knowledge.

That exception did not apply here, and the reasoning is worth understanding because it will apply to most owner-managers in the same position.

The company had been assessed as filed, then reassessed after it filed objections. The grounds the appellants were now raising were the same grounds the corporation had raised in its own objections, and those grounds were tied directly to positions the corporation had taken on its own returns. As the Court put it, the situation the appellants were complaining about originated from the corporation’s own filing.

That is not information locked inside CRA. It is information the taxpayer generated. The onus stayed with the appellants.

The accounts payable problem

The substance of the challenge was this. The company had supplier balances sitting in accounts payable, some of them for years. At some point they were taken into income, which increased taxable income even though no cash had come in.

The owner explained at trial how that happened. The accounts showed up as payables for years and years, until the bookkeeper told him that after a certain period he could not carry them further and had to take them into income. His response, in his own words, was that he knew nothing about accounting and told the bookkeeper to do what he had to do. The bookkeeper prepared it, took it into income, passed it to the accountant, and the accountant filed it.

Objections were filed on or about January 6, 2014 against the initial assessments, on the basis that income as filed had been overstated by accounts payable that were not income received in the year. Written representations followed on September 3, 2014.

Those representations confirmed that the company had obtained verbal confirmation from several suppliers of the existence of their accounts payable, but the representations did not list names or amounts. Only two suppliers, Forest Trim and Trillium Masonry Group, confirmed their balances in writing, for a total of $107,044.42. Although the company took the position that all of the accounts payable should be reversed, it concluded that resolving the objection on the basis of that $107,044.42 reduction was reasonable. The Appeals Division accepted that by letter dated September 30, 2014.

The appeals officer’s evidence was straightforward. She reviewed the documentation put in front of her, found sufficient materiality to adjust those two amounts, and when asked whether any further adjustment was possible, said there was no documentation to support one, although it had been requested.

Her cross-examination surfaced something owner-managers should note. Her role at the objection stage was to address what the taxpayer specifically raised, not to comb the file for relief the taxpayer had not asked for. Amounts the appellants did not put in issue were simply not under review. Nobody at CRA was looking for the rest of the payables on the taxpayer’s behalf.

Reassessments issued October 28, 2014 for 2010, 2011 and 2013 to reflect the accepted adjustment, February 5, 2016 for 2011 to reflect the loss carryback, and April 20, 2017 for 2012 and 2013 after a further carryback request made September 27, 2016. Those were the final reassessments, and the appellants did not displace the assumption that they were.

Why the evidence failed

At trial the appellants called only themselves.

The wife’s testimony was short. She described herself as a housewife with no training in tax or accounting. Her involvement with the company was helping with decorations and choosing colours and fabrics for the model homes, while she took care of the family and the home so her husband could devote his time to the businesses. She had never met the company’s accountants or the bookkeeper; she had seen the bookkeeper at her husband’s office but never met with him. She confirmed she was a 50 percent shareholder and had received dividends, but could not confirm the amounts with certainty.

The husband’s testimony was longer and, from an evidentiary standpoint, more consequential. About 40 years in construction, over 300 houses and other buildings, retired six or seven years. He was director, president and secretary, and approved everything from financing and purchasing through to selling and invoicing. He had no business or accounting training. He said he knew nothing about accounting, that a bookkeeper did all the journal entries using QuickBooks, that he approved invoices and signed cheques, and that he had never used QuickBooks himself and relied solely on the bookkeeper. On the returns, he said the accountant would tell him to sign here, and he signed, and the accountant sent it.

Taken to the general ledger, he described the construction projects at a high level but could not explain the numbers, specific accounts, or entries. Taken to a list of accounts payable organized by project, he described what each supplier did, but details about the numbers or the position of any particular supplier were not discussed. Taken to the financial statements for each year, he confirmed the figures on the page without being able to say why they were what they were. The Court’s summary was that he understood this to be his advisers’ responsibility.

He also confirmed on cross that the accounts payable were to be included in income on his bookkeeper’s advice, which he did not question with either the bookkeeper or the accountants, and that the company did not have the assets to cover the debt owed.

The Court found the attack on the reassessments rested on general statements. References to global annual amounts, itemized ledger entries without supporting evidence, and appeals to the economic reality of the years in question could not on their own discharge the burden. Restated financial statements were never filed. The only statements in evidence were the ones supporting the original filings.

Then two evidentiary points that every owner-manager should read twice.

First, the documents the appellants relied on most heavily, the general ledger extracts and the accounts payable list, were admitted only as background to the testimony, not as proof of their contents. A document that walks in as context does not prove the numbers printed on it. Somebody has to speak to it.

Second, the people who could have spoken to it were not there. Neither the accountants who prepared the financial statements nor the bookkeeper who made the accounting entries testified. The Court found that nobody involved in the treatment of the accounts payable in any respect, whether books, entries, process, analysis, valuation, or accounting presentation, gave evidence. And it noted pointedly that the owner still had occasional contact with the bookkeeper and had known him for fifteen to twenty years, calling it unfortunate that he was not called as a witness.

That is the case in one line. The one witness who could have explained the entries was reachable, and was not asked to come.

Argument two: our work was the consideration

The second argument went to the statutory test itself.

Section 160 measures the value transferred against the consideration given back. The appellants argued that because they had performed services for the company and had never been paid a salary for them, the dividends should be treated as consideration for that work. If the dividends were no more than the fair market value of the services, there would be no shortfall and no liability.

The owner put the intuition plainly in his testimony. He did not think he was liable, because he had not drawn a salary; it looked to him as though he was being compensated for his work, and the accountant gave it to him as a dividend. He looked at it as payment for his work.

Counsel was candid that this asked the Court to depart from a long line of authority. Following the Supreme Court of Canada in Neuman v. MNR, the Tax Court has consistently held that a dividend flows from share ownership rather than from services, and that the absence of a salary does not convert it into remuneration. The Federal Court of Appeal confirmed the same approach in Gilbert and, more recently, in Kufsky v. Canada, 2022 FCA 66.

The argument for departing from that line was drawn from the pandemic. In administering the Canada Emergency Response Benefit, the Minister accepted that amounts paid by a corporation to its owner-manager could include non-eligible dividends treated as employment or self-employment income. The Canada Emergency Business Account was extended to owner-operated businesses without payroll, including family-owned corporations that remunerate through dividends. The appellants argued that this was the government recognizing, at the worst possible time, the economic reality that owner-managers pay themselves by dividend, and that where section 160 is deliberately punitive, that recognition should be enough to reopen the question.

The Court declined, on three grounds.

First, the reasons offered were not sufficient to reconsider a long-standing position.

Second, stare decisis. Neuman is a decision of the Supreme Court of Canada, binding on the Tax Court.

Third, and most usefully for planning purposes, the Court was not persuaded that the federal government’s pandemic measures represented any change of position or policy bearing on the wording of section 160 or its judicial interpretation. Recognizing a commercial practice in the design of an emergency benefit is not a signal about the meaning of a collection provision. Reading it that way would extend the words beyond their context.

The Court closed the point with the observation that is the real lesson of the case. A decision was made to receive distributions under a specific mechanism. Different mechanisms can move the same cash to the same individuals, and not every mechanism is available in every circumstance, but declaring and paying a dividend was plainly available here and that is the choice the appellants made. The legal consequences of that choice must be applied.

The outcome

Both appeals were dismissed on May 31, 2024, following a two-day hearing in Toronto in June 2023. The appellants remain jointly and severally liable with the company for the corporate debt, with one set of costs payable to the Crown.

That costs award is a separate obligation. It is not part of the $245,398.18.

What owner-managers should take from this

Dividends are not payment for work. This is settled at the Supreme Court level, and Schonberger confirms it stays settled. If you want the value of your labour to count as consideration, it must be structured as compensation for labour, with documentation to match: a payroll account, source deductions, T4s, or a documented management fee supported by an agreement and an invoice trail. The label alone does not do the work. Calling a payment a salary does not immunize it from section 160 if the substance and the records do not support the characterization. The question is whether you can show that consideration of equivalent value actually moved in the other direction.

Section 160 belongs in your compensation analysis. Most salary-versus-dividend planning compares integration, RRSP room, CPP and the small business deduction. Add derivative liability to the list, particularly where the corporation carries any risk of a future assessment. Dividends out of a company with clean, current filings are one decision. Dividends out of a company with late returns, unresolved positions, or audit exposure are a different one.

There is no time limit. Subsection 160(2) permits assessment at any time. A dividend paid in 2010 produced a personal assessment in 2017, by which point the bookkeeper had moved on and the underlying explanations had gone with him. Every year without a defensible evidence file is a year of accumulating risk.

Watch what the penalty and interest do, and do not overestimate a carryback. Of the $245,398.18 assessed, less than $130,000 was tax. Interest ran on the corporate assessments until the day the spouses were assessed. And the 2014 loss carryback, which reduced Part I tax to nil for 2011 and 2012, still left $13,633.13 owing for 2011 in penalty and interest alone. If you are counting on a future loss to clean up a bad year, understand what it actually reaches. The cost of a slow file is not just the tax.

Documents do not speak for themselves. The general ledger and the accounts payable list were admitted as background, not as proof of their contents. A binder is not evidence of the numbers inside it unless someone who can explain those numbers is in the witness box. Ask, in advance, who that person would be.

Know who your witness is, and keep the relationship. The bookkeeper was reachable. The owner still spoke to him occasionally. He was not called, and the Court said so. If your position depends on why an entry was made, the person who made it has to be identified now and available later.

Do not rely on the objection stage to find relief you have not requested. The appeals officer reviewed what was raised and nothing else. Two suppliers produced written confirmation and produced a $107,044.42 reduction. The others produced nothing. That is what documentation is worth, and it is worth it only for what you actually put in issue.

Late filing compounds everything. Four years of financial statements finalized in the same week in September 2013, with returns following behind, is where the write-back originated. By the time it reached the Tax Court, the appellants were arguing that their own filed returns were wrong, with the burden of proof on them the entire way. That is the hardest position in tax litigation.

Watch the case breakdown

https://youtu.be/V_SUlPATLRw

Sources

• Income Tax Act, section 160: https://laws-lois.justice.gc.ca/eng/acts/I-3.3/section-160.html
• Schonberger v. The King, 2024 TCC 82: https://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/521287/index.do

Talk to us

If you are an incorporated business owner in Burnaby, Vancouver, Surrey, New Westminster, or anywhere in Metro Vancouver, and you are drawing money out of your corporation without a clear record of what those draws are, that is worth a conversation before it becomes a file.

At Cloudiverse CPAs we help owner-managers set up compensation properly, build year-by-year evidence folders that survive a CRA review, and identify the people who created the records while they can still be reached.

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Disclaimer

This article is general information only. It is not tax, legal, accounting, or other professional advice, and it does not create a client relationship. It reflects the law as of the date of publication and may not be current. Every situation turns on its own facts. Before acting on anything discussed here, consult a qualified professional about your circumstances.