Examining various tax implications in Ontario family law
Family law matters can have a multitude of tax implications. In this post, I will examine the implications of legal fees, spousal support, child support and pre-tax corporate income through the lens of taxation.
In certain circumstances, legal fees from family law disputes can be tax deductible. It appears this is reserved for individuals trying to obtain child support and/or spousal support. This was acknowledged in a Costs submission in Boland v Boland, 2012 ONCJ 239:
I agree with the submission of Cliff's lawyer that the fact that Elizabeth can claim a tax deduction for legal fees spent to obtain spousal support should be considered in this analysis.
The recent case of SB v VH, 2019 ONCJ 694, provides a more succinct analysis:
At ¶ 14 of Grenon v. R., 2014 TCC 265 (T.C.C. [General Procedure]), Justice Graham, of the Tax Court, wrote, "[t]here is no provision in the Act that specifically permits the deduction of legal fees by recipients of child support." Rather, the authority to deduct such legal fees appears to emanate from a combined reading of certain provisions of the Income Tax Act as they have been ministerially and judicially interpreted. It appears that child support falls within the statutory definition of "property" pursuant to section 248. Consequently, the cost to pursue it is tax deductible. Also at ¶14 of Grenon v. R., on this point Graham J. said, "[t]he justification for the deduction of these fees is based on the idea that such fees are amounts laid out to earn income from property..." and "income from a support payment is income from property and that as such the expenses incurred in obtaining the payment thereof may be deducted." See also the decision of the Federal Court of Appeal in Nadeau c. R., 2003 FCA 400 (F.C.A.).
These cases establish that such legal fees paid by a support recipient are tax deductible under the Income Tax Act. Interestingly, they also provide the authority for why legal fees paid by a support payor are not tax deductible.
This case stands for the proposition that an individual trying to obtain child or spousal support may be able to deduct all or part of their legal fees in obtaining said support.
Spousal support is generally tax deductible for the payor and taxable for the recipient. The recent case of Pierre v Pierre, 2021 ONSC 5650, demonstrates the law on spousal support in an order:
Commencing January 1, 2020, and continuing until August 31, 2021, the Father shall pay to the Mother $1,977 per month in spousal support, being mid-range support on his annual income of $183,515 and her annual income of $60,000. These spousal support payments will be taxable to the Mother and tax deductible to the Father.
In regular circumstances, the payor of spousal support will get to deduct the amount from their income and the recipient will have to pay tax on this income. However, this is not the case for lump sum spousal support (i.e. retroactive or prospective support paid all at once). This was demonstrated in Davies v Quantz, 2010 ONSC 416:
…a lump-sum payment of support is not tax deductible to him or taxable in the hands of Ms. Davies.
As such, lump sum payments are typically discounted for the tax implications that would have resulted if the spousal support was paid periodically.
Child support does not have any tax implications. The Child Support Guidelines provides a telling note on the child support tables used to calculate child support obligations:
The amounts in the tables are based on economic studies of average spending on children in families at different income levels in Canada. They are calculated on the basis that child support payments are no longer taxable in the hands of the receiving parent and no longer deductible by the paying parent. They are calculated using a mathematical formula and generated by a computer program.
As such, child support is not tax-deductible for the payor, nor does the recipient have to pay tax on it.
Section 7 Special or Extraordinary Expenses
Section 7 of the Federal Child Support Guidelines discusses special or extraordinary expenses. The presumption generally is that these expenses will be shared by the spouses in proportion to their income. Some of these expenses will have tax implications. One of the obvious section 7 expenses is tuition for post-secondary education for the child. This has the potential for major tax implications, and it’s addressed by section 7(d) of the guidelines:
Subject to subsection (4), in determining the amount of an expense referred to in subsection (1), the court must take into account any subsidies, benefits or income tax deductions or credits relating to the expense, and any eligibility to claim a subsidy, benefit or income tax deduction or credit relating to the expense.
In Razavi-Brahimi v Ershadi, 2007 ONCJ 406, the father was ordered to pay, retroactively, roughly $21,000 of tuition, which marked a significant portion of the tuition. In this case, the father was ordered to deduct the tuition from his own income, pursuant to the Income Tax Act.
Pre-tax corporate income
Pre-tax income may be considered in cases where the business owner is engaging in nefarious or inadvertent activities to reduce their support obligations to their spouse, whether for child or spousal support.
In LMP v MDP, 2021 ONSC 3577, the Respondent owned several corporations. One of the corporations, “the income producing entity”, was partly owned with a third-party corporation. The parties argued about how much income the Respondent earned from this corporation, through their respective expert reports. The Applicant’s report adduced an income of $820,000 for 2019 whereas the Respondent’s report adduced an income of $479,000. The difference was in the amount of pre-tax corporate income attributed to the Respondent’s corporation owned with the third-party.
The Court looked at the Child Support Guidelines, sections 15-20, regarding the determination of Income for the purposes of support:
The Child Support Guidelines provide for different methods of determining income when the starting point is not the "fairest determination of that income" does "not fairly reflect all the money available to the parent or spouse" or when a court "imputes such amount of income to a spouse as it considers appropriate."
The Court then examined section 18 in more detail:
18. (1) Where a parent or spouse is a shareholder, director or officer of a corporation and the court is of the opinion that the amount of the parent's or spouse's annual income as determined under section 16 does not fairly reflect all the money available to the parent or spouse for the payment of child support, the court may consider the situations described in section 17 and determine the parent's or spouse's annual income to include,
(a) all or part of the pre-tax income of the corporation, and of any corporation that is related to that corporation, for the most recent taxation year; or
(b) an amount commensurate with the services that the parent or spouse provides to the corporation, provided that the amount does not exceed the corporation's pre-tax income. O. Reg. 391/97, s. 18 (1).
By virtue of the use of the word 'may' in section 18 of the Child Support Guidelines, the court has discretion to add all or part of a corporation's pre-tax income to a payor's income if the payor's annual income, as determined under section 16 of the Child Support Guidelines, does not fairly reflect all money available to the payor for the payment of support.
According to section 18(2) of the Child Support Guidelines:
In determining the pre-tax income of a corporation for the purposes of subsection (1), all amounts paid by the corporation as salaries, wages or management fees, or other payments or benefits, to or on behalf of persons with whom the corporation does not deal at arm’s length must be added to the pre-tax income, unless the spouse establishes that the payments were reasonable in the circumstances.
The Court came to three questions when deciding whether to exercise its discretion in this circumstance:
(a) does the Respondent have control over dividend declarations?
(b) is there a business reason for retaining the earnings?; and
(c) should the court exercise its discretion and attribute pre-tax corporate income?
The first question relates to the amount of control that the Respondent exercises over the company. This question is paramount; if the Respondent does not have the ability to increase his dividend, how would he pay the support? The Court found:
M.D.P. is a 50% owner. He is not a minority owner.
M.D.P., by his own admission, effectively exercises control over whether dividends are declared and what earnings are retained.
It is important to note that the nature of this business is marketing and distribution.
As stated, Abutment Direct Inc.'s directors are M.D.P. and two directors appointed by Medentika. Most issues are decided by majority vote.
There was no evidence provided to the court to suggest that, historically, when M.D.P. determined a dividend, that he was overruled by the votes from the two directors for Medentika. As I understand the evidence, the business relationship between Abutment Direct Inc. and Medentika has been in place for over 10 years during which M.D.P. has determined the amount and timing of a dividend.
Evidence of manipulation, bad faith or intentional avoidance of support obligations is not a prerequisite to imposing section 18 of the Child Support Guidelines.
For all of these reasons I conclude, on the evidence before me, that M.D.P. has effective control over dividend declaration.
The next question was whether there was a business reason to retain earnings. The Court would not want to jeopardize the business by making the Respondent pay dividends that the company could not afford. The Court essentially concluded that the corporation was simply holding money, and paying less dividends than it could, without any justification. With that, the Court went through a detailed analysis of the company’s financials.
The final question is whether the Court should exercise its discretion and attribute pre-tax corporate income. In other words, despite all the aforementioned, the Court has the discretion to decide whether they will proceed:
Not including available pre-tax corporate income would, in my opinion, result in an unfair result.
I have considered that Abutment Direct Inc. carries no debt.
The court was provided no evidence of extraordinary business losses or upcoming capital requirements.
An examination of Abutment Direct Inc.'s financial records indicates a fiscally healthy company.
For all of those reasons I am satisfied, on the evidence before me, that pre-tax corporate income should be included as income to the Respondent as it better reflects the income available to the Respondent for the purpose of establishing an appropriate quantum of spousal support and child support
The above case shows the complexities family litigants must contend with when trying to establish what the business owner should have to pay for the purposes of support. An easy starting place is an examination of the pre-tax income.
Obvious takeaways? Parties should always be cognizant of the tax implications in family law. Spousal support is tax deductible in the hands of the payor and taxable in the hands of the recipient. While child support is not tax deductible or payable, special or extraordinary expenses can have tax implications in certain circumstances. Finally, spouses of company owners ought to be cognizant of the pre-tax income of the corporation, in order to ensure they are receiving a fair award.