Section 160 leads to derivative tax liability for 50-50 shareholders who receive dividends from a tax-debtor corporation

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm.

Introduction

Derivative Tax Liability under Section 160 of Canada's Income Tax Act & Dividends from Tax-Debtor Corporations

Section 160 of Canada's Income Tax Act is a tax collection tool. It thwarts taxpayers who try to hide assets from the Canada Revenue Agency's tax collectors by transferring those assets to friends, relatives, related corporations, or shareholders.

Section 160 captures a broad range of transactions, including dividend payments. The Tax Court's decision in McCague v The King, 2025 TCC 59, illustrates that, if you receive a dividend from a corporation that has outstanding income tax debts, section 160 allows the CRA's tax collectors to chase you for those income tax debts.

If the amount of the dividend is less than the corporation's income tax debt, your derivative tax liability is capped at the amount of the dividend. You can also reduce the derivative tax liability by showing that you provided consideration for the asset that you received from the tax debtor.

In McCague, the taxpayer adopted a different strategy: arguing that he and the corporation dealt on arm's-length terms because he owned exactly 50% of the corporation's shares and therefore didn't control the corporation.

The Tax Court recognized the merit of this line of reasoning but made it clear that this strategy doesn't guarantee a win. This is because "although the payment of a dividend on a 50-50 shareholding is not automatically one that is the result of a non-arm's-length transaction, it does remain a type of transaction that is more likely to attract scrutiny as one resulting from acting in concert."

The Mechanics of Section 160 of Canada's Income Tax Act

Section 160 applies if all the following four conditions have been satisfied:

1. A property was transferred. The language of section 160 contemplates a broad range of transfers: it covers situations where a tax debtor "transferred property, either directly or indirectly, by means of a trust or by any other means whatever."
2. At the time of the transfer, the transferor owed a tax debt to the Canada Revenue Agency.
3. At the time of the transfer, the recipient was one of the following: (a) the transferor's spouse or common-law partner (or a person who has since become the transferor's spouse or common-law partner); (b) a person who was under 18 years of age; or (c) a person with whom the transferor was not dealing at arm's length—e.g., a trust or corporation in which the transferor holds an interest.
4. The recipient provided the transferor with consideration that was worth less than the transferred property's value.

In other words, section 160 catches any transaction whereby you received assets from a related party with outstanding tax debts, and you didn't provide full consideration in return — e.g., a dividend from a tax-debtor corporation, a gift of cryptocurrency or non-fungible tokens from a friend or relative with tax debts, a monetary gift from a spouse with tax debts, etc.

When section 160 applies, the transferor and the recipient both become "jointly and severally" liable for the transferor's tax debt. As such, the recipient becomes independently liable for the transferor's tax debt at the time of the transfer.

This means that the Canada Revenue Agency's tax collectors can now pursue both the original tax debtor and the derivative tax debtor for the tax debt. In fact, even if the original tax debtor is later discharged from bankruptcy and thereby released from the underlying tax debt, the derivative tax debtor remains liable to the CRA until the tax debt is fully repaid: Canada v Heavyside, 1996 CanLII 3932 (FCA).

Subsection 160(3) of Canada's Income Tax Act governs how payments apply to discharge the joint liability. A payment by a taxpayer who inherited liability under section 160 will reduce both debts — that is, such a payment reduces not only the tax debt of the jointly liable third-party taxpayer but also the tax debt of the original tax debtor. But an ordering rule governs a payment by the original tax debtor.

The original tax debtor must first pay off all tax debts exceeding the joint debt. In other words, before her tax payments can discharge the joint debt, the original tax debtor must first pay off all tax arrears belonging solely to her. Only then can the original debtor's payments extinguish the joint debt.

Section 160 is a notoriously harsh rule: It offers no due-diligence defence, it applies even if the transaction wasn't motivated by tax avoidance, and it catches transferees who don't even realize that they're receiving property from a tax debtor (e.g., see: Canada v Heavyside, 1996 CanLII 3932 (FCA), at para 3).

In addition, section 160 doesn't contain a limitation period. So, even several years after the purported transfer, the Canada Revenue Agency's tax collectors can still assess you for derivative tax liability under section 160.

(Section 325 of Canada's Excise Tax Act contains a similar rule relating to derivative liability for GST/HST debts. Hence, section 160 of the Income Tax Act bestows derivative income tax liability for transfers by a person with income tax debts; section 325 of the Excise Tax Act bestows derivative GST/HST liability for transfers by a person with GST/HST debts.)

Yet there are a few limits on the extent of the transferee's derivative tax liability. First, the transferee's derivative tax liability under section 160 is capped at the fair market value of the transferred property. Second, the transferee's liability is also offset by the amount of any consideration that the transferee provided for the property.

Suppose, for instance, that a corporation owes $1 million in income tax debt to the CRA. The corporation pays a $25,000 dividend to a shareholder, and it pays another $25,000 in salary to that shareholder in his capacity as an employee. The shareholder's derivative liability under section 160 is $25,000 — i.e., the value of the dividend. As an employee, however, the shareholder doesn't incur any derivative liability under section 160 because, as an employee, he provided consideration for the $25,000 salary—namely, his services.

Finally, when assessing a taxpayer for derivative tax liability under section 160, the Canada Revenue Agency typically bears the burden of proving the existence of the underlying tax debt. This reversed onus contrasts with the onus that generally applies in Canadian tax disputes.

For the most part, in Canadian tax disputes, the Canada Revenue Agency may make factual assumptions — that is, assume the facts favouring the CRA's position without proving that those facts are true — and the taxpayer bears the initial burden of disproving the CRA's factual assumptions.

But when the Canada Revenue Agency issues a derivative-liability assessment under section 160 of the Income Tax Act, the burden may be flipped. In particular, the CRA bears the burden of proving the existence of the underlying tax debt "where the facts concerning the underlying tax debt are exclusively or peculiarly within the [CRA's] knowledge": Mignardi v The Queen, 2013 TCC 67, at para 41.

In these cases, the tax jurisprudence reverses the onus that would otherwise apply, forcing the Canada Revenue Agency to prove the dispositive facts as opposed to merely assuming them. Therefore, the derivatively assessed taxpayer may challenge the initial, underlying tax debt, thereby forcing the CRA to prove the correctness of the third-party tax assessment underlying the section 160 liability.

McCague v The King, 2025 TCC 59: 50% Shareholder Falls Prey to Derivative Tax Liability Stemming from Dividends

McCague was a 50% shareholder of a numbered corporation. McCague wasn't related to the individual who owned the other 50% of the corporation's shares.

At a time when it owed over $76,000 in corporate income tax, the corporation paid a dividend to McCague. The CRA's tax collectors consequently assessed McCague for $76,000 in derivative tax liability under section 160 of Canada's Income Tax Act.

McCague's lawyer disputed the section 160 assessment, first by filing a notice of objection with the CRA's Chief of Appeals and then by filing a notice of appeal, which brought the dispute before the Tax Court of Canada.

Appearing before the Tax Court of Canada, the parties tasked the court with answering a single, crucial legal question: At the time that McCague received the dividend, did McCague and the corporation deal with one another at arm's length?

Section 160 of the Income Tax Act requires a transfer to occur between parties who deal with one another on non-arm's-length terms — that is, who are in a non-arm's-length relationship. The general rule under the Income Tax Act is that a shareholder and a corporation are in a non-arm's-length relationship if that shareholder controls the corporation.

But McCague held exactly 50% of the corporation's shares, and as the court recognized, "the whole point of a 50-50 shareholding arrangement is not to give control to any one party but rather to give each shareholder a veto to block any one party from exercising control": para 44.

In addition, McCague and the other 50% shareholder didn't meet the Income Tax Act's definition of "related persons." In other words, McCague didn't legally control the corporation, and McCague and the other shareholder didn't qualify as "related persons."

In these circumstances, courts turn to the final non-arm's-length test in paragraph 251(1)(c), which states: "in any other case, it is a question of fact whether persons not related to each other are, at a particular time, dealing with each other at arm's length." Hence, to determine whether McCague and the corporation dealt with one another at arm's length, the court needed to examine the facts surrounding the dividend payment.

In Canada v McLarty, 2008 SCC 26, the Supreme Court of Canada noted the following criteria for the purposes of determining whether parties factually dealt at arm's length:

• Was there a common mind that directed the bargaining for both parties to a transaction?
• Were the parties to a transaction acting in concert without separate interests?
• Was there de facto control?

The Tax Court of Canada's analysis focused on the acting-in-concert criterion from McLarty. In doing so, the court distinguished between dividend payments made for a business purpose, such as facilitating a buyout or restructuring, and those made primarily to serve the personal financial interests of the shareholders.

Here, the court found that the dividend served McCague's personal financial interests, and that McCague and the other shareholder did indeed act in concert when causing the corporation to declare the dividends. The court also clarified that the shareholders needn't seek the dividend for the same purpose; it sufficed that the purpose was personal in nature:

"[...]I take issue with the way that the appellant framed his "common interest" argument. Counsel for Mr. McCague suggested that the reasons why [the other shareholder] may have wanted a dividend were not necessarily the same as or aligned with those of Mr. McCague. However, as I have already indicated, this argument takes the inquiry too far into the nature of the personal reasons of each shareholder rather than the common nature of the reasons, i.e. that their reasons were personal and not related to the business. McCague paid his credit cards, contributed to his RRSPs and took a much-needed vacation. Whether [the other shareholder] did the same thing or did something else with the money is unknown and irrelevant. What matters is that they both wanted [the corporation] to disgorge its retained earnings for personal reasons and they acted in concert to make that happen." [para 67].

The court therefore concluded that McCague and the corporation were in a non-arm's-length relationship at the time that McCague received the dividend. As a result, the court dismissed McCague's tax appeal and upheld his $76,000 derivative tax assessment.

Avoiding & Responding to Derivative Tax Assessments under Section 160 of the Income Tax Act & Section 325 of the Excise Tax Act

If you receive dividends from a corporation with outstanding income tax debts or GST/HST debts, you're exposed to derivative tax liability under section 160 of the Income Tax Act or section 325 of the Excise Tax Act.

There are several common strategies for challenging a derivative tax assessment under section 160 or section 325. For example, you can show that the transferee provided fair-market-value consideration at the time of the transfer, or you can dispute whether the transferor owed tax at the time that the transfer occurred.

The McCague case illustrates another strategy for derivative tax assessments involving a shareholder who receives dividends from a corporation that the shareholder doesn't control. It may be possible to establish that the shareholder and the corporation dealt on arm's-length terms at the time of the dividend. But the McCague case makes it clear that your response will succeed only if it aligns with the governing legal principles and finds support in the available evidence.

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm and is a Certified Specialist in Taxation Law who has completed the CICA in-depth tax planning course. He appears regularly in print, radio and TV and blogs extensively.  

With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation. Visit www.Taxpage.com and email David at david@taxpage.com.

Read the original article in full on Tax Page. Author photo courtesy Rotfleisch & Samulovitch P.C. Title image: iStock ID 614438558 (modified).