Friday, March 24, 2023

CRA taken to court docket after denying help funds as tax deductible

Jamie Golombek: There are tax penalties to take into consideration when making a separation settlement

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Among the many challenges of separation and divorce is figuring out whether or not spousal and little one help shall be payable, and, if that’s the case, how a lot and for the way lengthy. For anybody going by means of this course of, it’s vital to take the tax penalties under consideration when structuring a separation settlement.

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The Earnings Tax Act distinguishes between spousal help and little one help, with completely different tax rules for every. Spousal help consists of any quantities paid on a periodic foundation, below a court docket order or settlement, for the help of a former partner or common-law companion. Baby help, however, consists of any help funds that aren’t particularly recognized in that order or settlement as being just for the previous partner’s or companion’s use. In each circumstances, the previous spouses or companions have to be dwelling aside after the breakdown of their marriage or relationship.

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If the court docket order or separation settlement solely supplies help for a partner or companion, then the funds are totally taxable to the recipient and tax deductible to the payor. To make sure tax deductibility, the order or settlement have to be registered with the Canada Revenue Agency. To take action, the previous spouses or companions ought to full CRA Form T1158 Registration of Family Support Payments and embrace a duplicate of the order or settlement.

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If, however, the order or settlement is solely for the help of kids, the funds are neither taxable to the recipient nor tax deductible to the payor, so there isn’t a must register the settlement with the CRA.

If the settlement incorporates each spousal and little one help, and it clearly signifies a separate quantity for a partner or companion, then this portion of the funds shall be deductible and taxable. However how formal does the settlement have to be for the help funds to be tax deductible? A latest tax case handled this particular problem.

The case concerned a taxpayer who received married in 2006, and legally separated on Dec. 8, 2010. In March 2011, the couple entered a separation settlement, signed by each events. The couple selected to organize the separation settlement on their very own with out utilizing legal professionals. Within the part coping with spousal help, the settlement said: “Social gathering 1 shall pay spousal help to occasion 2 within the quantity of $3,500 month-to-month commencing Dec 8/10 and ending Dec 8/14.”

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The dispute with the CRA, nevertheless, concerned the 2018 taxation 12 months as a result of the taxpayer continued to make spousal help funds past the 2014 finish date of their settlement. On his 2018 tax return, he deducted spousal help funds of $42,000 (12 instances $3,500), whereas his ex-spouse included the $42,000 on her return as earnings.

Canada Revenue Agency tax forms.
Canada Income Company tax varieties. Picture by Peter J. Thompson/Nationwide Put up

The CRA reassessed the taxpayer and denied his deduction for spousal help on the idea that the funds didn’t fall throughout the definition of “help quantity,” as a result of, within the CRA’s view, the spousal help funds weren’t made by the taxpayer pursuant to a written settlement.

The choose reviewed the 2011 separation settlement and referred to as it “flawed from the outset.” He famous the signatures of the spouses weren’t witnessed, and there was a handwritten clause on the backside of the contract stating the settlement was “topic to approval by authorized counsel.” There was no indication such approval was ever obtained.

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Nonetheless, the truth is that the 2 separated spouses honoured the phrases of the written settlement, with the taxpayer paying $3,500 monthly in spousal help all through the time period of the settlement and for a number of years thereafter.

The taxpayer took the place that the March 2011 separation settlement, regardless of not being correctly up to date after 2014, constituted an settlement in writing below which he made help funds in 2018.

The CRA argued the help funds in query weren’t made pursuant to a written settlement. The beforehand current separation settlement had expired in 2014, and, subsequently, no settlement obliging the taxpayer to pay spousal help existed in 2018.

The choose famous in his evaluation that there was a variety of litigation regarding the problem of whether or not help funds have been made pursuant to a written settlement. As to why a written settlement is important, he quoted a previous choice of the Federal Courtroom of Attraction that concluded: “The rationale for not together with separated spouses concerned in funds made and acquired pursuant to a verbal understanding is quickly obvious. Such a free and indefinite construction may properly open the door to colourable and fraudulent preparations and schemes for tax avoidance.”

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The choose then turned to the information of this case, which he famous “is clearly not a fraudulent scheme.” The events agreed in 2011 in writing to an quantity to be paid as spousal help. They “incorrectly ignored” the necessity to replace the contract in 2014 as a way to correctly replicate the taxpayer’s continued help obligations.

However because the two events continued to contemplate themselves sure by their 2011 separation settlement by means of the 2018 taxation 12 months, such conduct helps the conclusion {that a} “assembly of the minds continued to exist regarding spousal help obligations.” In different phrases, the help established within the 2011 separation settlement was handled by the events as persevering with to be in pressure as much as, and together with, 2018.

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The choose, “guided by the plain that means of the phrases of the act,” concluded the funds have been, certainly, made pursuant to the phrases of a written settlement. The funds happy the necessities below the Earnings Tax Act that the help was “an quantity payable … on a periodic foundation for upkeep … below a written settlement,” and thus needs to be tax deductible to the taxpayer on his 2018 return.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Property Planning with CIBC Personal Wealth in Toronto.


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