Why a Late Separation Agreement Failed to Stop the CRA ?

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Transferring the family home into one spouse’s name during a marriage breakdown is one of the most common things a family lawyer will paper. It is also one of the most common ways a spouse inherits a tax debt they had nothing to do with.

Section 160 of the Income Tax Act lets the Canada Revenue Agency collect a taxpayer’s tax debt from someone else. If you received property from a tax debtor for less than fair market value, and you were the debtor’s spouse, a minor, or a person not dealing at arm’s length with them, you can be assessed personally for that debt. Your knowledge of the debt is irrelevant. Your intention is irrelevant. The provision has no limitation period, so the assessment can arrive years after the transfer.

The Tax Court of Canada’s decision in Lim v. The King, 2024 TCC 135, shows exactly how the provision operates when a matrimonial property transfer and an unpaid tax bill overlap. The recipient spouse was assessed for $389,725.47. She appealed. The Court dismissed the appeal and confirmed the assessment in full.

The case is worth reading closely because the outcome turned on a calendar, not on anyone’s good faith.

The chronology

In 2015 the transferor spouse owned four corporations operating restaurants, with a combined estimated fair market value of roughly $1,060,000. He also had an outstanding personal tax liability of $389,725.47.

Three dates decided the case.

July 8, 2015. The transferor spouse transferred his 50% joint interest in the matrimonial home to the recipient spouse, making her the sole registered owner.

December 1, 2015. The parties separated.

November 14, 2016. The parties signed a formal written separation agreement.

The transfer came first. The separation came almost five months later. The written agreement came sixteen months after that. The Minister assessed the recipient spouse for $389,725.47 on the basis that the July 2015 transfer was a non-arm’s length transfer for no consideration made at a time when the transferor owed tax.

How section 160 actually works

Subsection 160(1) applies where a person has transferred property, directly or indirectly, by means of a trust or by any other means whatever, to their spouse or common-law partner, to a person who has since become their spouse or common-law partner, to a person under 18 years of age, or to a person with whom they were not dealing at arm’s length.

Where those conditions are met, paragraph 160(1)(e) makes the transferee and the transferor jointly and severally liable for the lesser of two amounts:

  1. the amount, if any, by which the fair market value of the property at the time it was transferred exceeds the fair market value at that time of the consideration given for the property; and
  2. the total of all amounts the transferor is liable to pay under the Act in or in respect of the taxation year in which the property was transferred or any preceding taxation year.

Two features of that formula catch people out.

The first branch is a shortfall, not a value. It is what you received minus what you actually paid. Pay full market value and the shortfall is nil, no matter how large the transferor’s debt.

The second branch is a ceiling set by the transferor’s debt. The CRA cannot collect more from you than the transferor owed, but within that ceiling it can collect the entire shortfall.

There is one more mechanical rule worth knowing. Subsection 160(3.1) deems the fair market value of an undivided interest in property, expressed as a proportionate interest, to equal that same proportion of the fair market value of the property. That is what makes a 50% interest in a jointly held home a straightforward number to assess.

The arithmetic the Court worked through

The Court moved through the statutory test in order.

Step one: value the transferred property. The matrimonial home was estimated at $1,600,000. The transferor spouse’s 50% equity interest as at July 8, 2015 was valued at $508,778.50. That figure is equity, net of the mortgage, and not simply half the gross value of the house.

Step two: value the consideration. The recipient spouse argued that in June 2015 she had verbally agreed to forbear from claiming any interest in the restaurant businesses in exchange for the interest in the home. The Court found no evidence supporting the existence of that verbal agreement. Worse for her position, the 2016 separation agreement actually transferred one of the restaurants, worth approximately $500,000, to her. That was difficult to reconcile with a claim that she had given up her rights to the businesses a year earlier. The Court valued the consideration at $0.

Step three: calculate the shortfall. $508,778.50 less $0 is $508,778.50.

Step four: identify the ceiling. The transferor spouse’s outstanding tax liability at the time of the transfer was $389,725.47.

Step five: take the lesser. $389,725.47 is less than $508,778.50, so the assessment stood at $389,725.47.

The recipient spouse’s liability was capped by her former husband’s tax debt, not by the value of the house. Had the home been worth less, her exposure would have dropped. Because the home was worth more, she absorbed the entire debt.

Why the forbearance argument failed

Forbearance can be consideration. Agreeing not to enforce a right you actually hold is a recognized form of value in contract law, and the Federal Court of Appeal has acknowledged as much.

The difficulty in this case ran in two directions.

Evidentially, there was nothing to prove the June 2015 verbal agreement existed. In section 160 litigation the taxpayer carries the burden of displacing the Minister’s assumptions, and a recollection of a conversation, without documents or corroboration, rarely does it. The subsequent conduct of the parties then cut against her account, because the restaurant she supposedly gave up rights to was transferred to her in 2016.

Legally, the problem is more fundamental. In Yates the Federal Court of Appeal held that surrendering spousal rights under provincial family law does not displace joint liability under section 160. There is no family law exception written into the provision. A spouse cannot avoid a derivative assessment by characterizing the transfer as their fair share of matrimonial property, because the right to an equalization or a division of family property is not consideration that the Income Tax Act recognizes as reducing the shortfall under paragraph 160(1)(e).

This is the point most business owners get wrong. What is a completely normal division of assets under provincial family law can still be a transfer for no consideration under federal tax law. The two statutes are asking different questions.

Why subsection 160(4) did not save the transfer

Parliament did build a carve out for genuine marriage breakdowns, but it is narrow and it is conditional.

Subsection 160(4) applies where a taxpayer has transferred property to their spouse or common-law partner pursuant to a decree, order or judgment of a competent tribunal or pursuant to a written separation agreement, and, at that time, the taxpayer and the spouse were separated and living apart as a result of the breakdown of their marriage or common-law partnership. Where it applies, the fair market value of the property at the time of transfer is deemed to be nil for the purposes of paragraph 160(1)(e).

That deeming rule is powerful. If the value is nil, the shortfall in the first branch of the test is nil, and the lesser of nil and the transferor’s debt is nil. The assessment collapses entirely.

But look at what has to be true, and when.

The transfer must be made pursuant to a decree, order, judgment, or written separation agreement. Not followed by one. Pursuant to one. That requires the instrument to exist and to be the reason the property moved.

The spouses must already be separated and living apart because of the marriage breakdown at the time of the transfer. Not later that year. At that time.

The July 8, 2015 transfer failed both conditions. The parties were still together, and there was no written agreement in existence, let alone one the transfer was made under. The separation followed in December. The agreement followed the year after. Neither could reach backward.

What this means for business owners and families

Sequence is the whole game. A transfer made before the separation and before the agreement sits outside subsection 160(4) even when the marriage breakdown that eventually happens is completely real. If matrimonial property is going to move, the separation and the written agreement need to precede the transfer, and the transfer needs to be made under that agreement.

Check the transferor’s tax account before the title changes. The provision bites where there is a tax debt in or in respect of the year of transfer or any earlier year. Corporate tax debts, payroll remittances, GST/HST, and unfiled years that later produce assessments all matter. A spouse who signs a transfer without knowing the state of the other spouse’s account is accepting an unpriced liability.

Document consideration in dollars, contemporaneously. If a spouse is genuinely giving something up, the agreement should say what, say what it was worth, and be signed at the time. A verbal understanding recalled in Tax Court years later is not going to carry the burden of proof.

Do not rely on family law entitlement as consideration. Giving up a claim to an equalization payment or a share of a business does not reduce a section 160 shortfall. The Income Tax Act does not treat it as value given.

Remember there is no time limit. Subsection 160(2) permits the Minister to assess a transferee at any time. A transfer done in 2015 can produce an assessment well into the next decade if the underlying debt stays unpaid.

Watch for the anti-avoidance rule. Subsection 160(5) deems parties to be non-arm’s length and can deem debts to have become payable in the year of transfer where one of the purposes of the arrangement was to avoid joint liability or to avoid a future tax debt. Restructuring around section 160 with that purpose in mind tends to make the problem worse, not better.

The recipient spouse in this case did not set out to defeat the CRA. She ended up personally liable for $389,725.47 because a title transfer happened on the wrong side of a date. That is a solvable problem, but it has to be solved before the transfer, not after the assessment.

If you are contemplating a matrimonial property transfer and either spouse has corporate or personal tax exposure, the tax sequencing should be settled alongside the family law advice, not after it.

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Disclaimer

This article is general information about a court decision, not advice for your situation. Tax outcomes depend on the specific facts, and the rules change. Talk to a CPA or a tax lawyer before you act on anything here. Reading this article does not make you a client of Cloudiverse CPAs Inc.