In Trower v. the Queen, 2019 TCC 77, the Company was privately held by the taxpayer and her spouse (49% and 51% respectively) until the taxpayer ceased to be shareholder in the Fall of 2016, pursuant to a separation agreement between the spouses.
The company prepared and filed a T5 tax slip to document that dividends were paid in 2016 to the taxpayer prior to her ceasing to be a director and the taxpayer was assessed accordingly. The taxpayer appealed the assessment on the basis she never received the funds.
Based on the evidence provided, it appears that funds were historically transferred directly from the Company’s bank account either to a joint account that the taxpayer and her spouse maintained prior to separation, or to the taxpayer or her former spouse’s personal accounts.
The Tax Court noted that the character of any of these payments cannot be determined simply from the fact that there were transfers. For example, those payments could have been advances, loans, consulting fees, employment income earned by the taxpayer’s spouse, returns of capital on shares, dividends, reimbursement of expenses, repayment of advances from shareholders, etc. Accordingly, to determine whether any or all these payments were dividends required an examination of other evidence.
The taxpayer testified that, although she had agreed to income-splitting with her former spouse for years prior to 2016, she had consistently advised him that she was not interested in income-splitting for 2016. Also, even though she had agreed to income-split in prior years, effected through a dividend payment to her by the Company, she did so without understanding the tax consequences.
The taxpayer’s former spouse did not dispute that the taxpayer had told him a number of times that she did not want any dividends. However, the taxpayer’s spouse contended that the taxpayer should have understood that income splitting would have to occur in 2016 since she had agreed to the pattern of receiving the dividends in prior periods.
The spouse stated that, as they were both shareholders, they both should receive dividends and that, because the taxpayer had full access to the funds in the joint bank account, funds deposited by the Company to the joint bank account should be treated as dividends paid to her.
The Tax Court noted that funds deposited to the joint account does not mean that they are income to the taxpayer or her spouse. While it is true that both joint holders may have access to the funds, that does not determine the character of the funds deposited to the account. To determine character of the funds, the tax analysis flows from the commercial relationships of the parties. Under corporate law, no dividend is payable until such time as it is declared. In this case the dividend was not declared (or approved) until February 2017 and thus no dividend was payable in 2016.
The taxpayer was a director of the company for approximately 9 months of 2016, a period during which she consistently was objecting to dividend payments. In the Court’s view, payments made when she was one of two directors would have required her to authorize and declare dividends. The evidence was that no amount was paid by the Company in 2016 before the taxpayer resigned in 2016. and therefore, could not have received any dividends the taxpayer’s spouse have approved after that date.
The Tax Court found that all the evidence led to the conclusion that the two persons who were required to authorize dividends on behalf of the Company never agreed that the transfers would be dividends. The decision was a unilateral one by the taxpayer’s spouse, as he admitted in his testimony that the resolution approving the dividend payments was prepared and signed in 2017, at that time that he was the sole director and shareholder of the Company.
Ultimately, the Tax Court found that at no time prior to the taxpayer’s resignation in 2016, had the relevant transfers been approved as dividends. Absent the taxpayer’s agreement, the Tax Court found the payments could not be and are not dividends paid to the taxpayer in 2016. The Tax Court found for the taxpayer and quashed the assessment.
I found this case to be a very good reminder that all transactions resulting from income splitting, estate and trust plans for example and involving cash and other proceeds, should be supported by good record keeping and vice versa, to avoid disputes and misunderstandings, and perhaps expensive litigation.