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Gifting assets can come with a nasty tax surprise

A man from Burnsville, Minn., was arrested last year after forcibly entering the home of his neighbour. It turns out that Alfred Guercio, the culprit, entered the home to steal a knife set that he had given his neighbour for Christmas. Mr. Guercio was angry at his neighbour for not appreciating and using the gift, so he told the neighbour that if she wasn't going to use the knives, he wanted them back. He then forced his way past the neighbour, made his way to the kitchen, grabbed the knives and left.

Gift giving is a dangerous sport. It can backfire in many ways. Maybe the recipient won't like the gift. Perhaps the recipient already has two pet rocks and doesn't need a third. Or maybe your gift will be accompanied by a tax liability. No kidding. A recent court decision serves as a reminder that gifting assets can backfire when the giver owes the taxman money.

Let me explain.

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The story

Last year, the Tax Court of Canada handed down a decision in the case Loates v. The Queen. That decision saw Bernard Loates liable for more than $158,000 in taxes that weren't his taxes to pay originally. He appealed the decision, and on Feb. 9, the Federal Court of Appeal announced it had reviewed the grounds of appeal and concluded that the Tax Court had not made any errors in Mr. Loates's case. So, he struck out again. His story is a common one, and the results might catch you off guard if you find yourself in a similar situation.

Here's the story: Mr. Loates's wife owned a vacation home that was worth about $700,000 in 2005. The property was in her name alone. The city home was their matrimonial home, although that property, too, was in her name. On March 15, 2005, she transferred ownership of the vacation property to Mr. Loates at a time when she owed $158,058 to the taxman related to her 1998-through-2001 taxes. In return, Mr. Loates gave up any interest he might have had in the matrimonial home, so that they each owned one property.

The law

Section 160 of our tax law can catch you by surprise. This section can cause you to become liable for the tax bill of another person if they make a gift to you at a time when they owe taxes to the Canada Revenue Agency. Specifically, the section will apply where the transferor owes money to the CRA at the time the transfer is made, assets are transferred to you directly or indirectly (i.e. through a trust or some other manner), and you are the spouse or common-law partner, a minor child or someone else not dealing with the transferor at arm's length. There's one other condition that must be met: The value of the assets you receive from the transferor must be higher than what you give back in return.

If these conditions are met, you'll be liable for the tax bill of the transferor to the extent you didn't pay for the asset you've received. In the case of Mr. Loates, he was liable for his wife's taxes. He tried to argue that he did in fact give something of value back in return for receiving the vacation property. Specifically, he argued that he had lent his wife money prior to the transfer date, so she owed him money and the transfer of the vacation property to him was partial repayment. The problem? There was no evidence of the loans.

Next, Mr. Loates argued that he had given an asset of value back to his wife when she transferred the vacation property to him. Specifically, he gave up his share of the city home to her when she gave him the vacation home. It's interesting to note this wasn't good enough even though the city home was worth much more. Based on a prior court case (Yates v. Canada), the surrender of spousal rights, even if properly valued, evidenced and arithmetically accurate, does not override the joint liability of Mr. Loates for his wife's tax debt where Section 160 otherwise applies.

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Mr. Loates also tried to argue that the vacation property had no value after taking into consideration two mortgages on the property. The court didn't buy that argument either for certain reasons.

The moral

When an asset is transferred from one person to another who is related or not dealing at arm's length, it's important to understand if the transferor owes tax at that time. If so, careful planning is needed to avoid the transferee becoming liable, too.

Tim Cestnick is managing director of Advanced Wealth Planning, Scotia Wealth Management, and founder of WaterStreet Family Offices.

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About the Author
Author and founder of WaterStreet Family Offices

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices. More


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