Non-arms-length transfers are transactions between individuals who are related by blood, marriage, common-law partnership or adoption. Non-arms-length transfers are generally not considered market value. In addition, these transactions do not eliminate shareholder’s liability. Tax liability for non-arms lengths transactions is discussed in Section 160 of the Income Tax Act.
This section indicates that tax liability is shared if property is transferred at less than fair market value. Therefore, if, as a shareholder of a corporation, you are liable for tax debt, this debt does not disappear if you transfer your shares to a spouse or other relative. Instead, both of you become jointly responsible for the debt.
However, shareholder’s liability in a corporation is generally limited to the amount of investment in a corporation. This limited liability is one of the most beneficial aspects of incorporation in Canada. That said, in some cases, a shareholder is required to personally guarantee the debts of a corporation.
In addition, directors of a company can be held responsible for various personal liabilities such as unpaid employee wages and unremitted income tax, GST, PST and HST.
In Canada, corporate income taxes are determined separate from the shareholders. However, dividends to shareholders are considered income and, thus, they are taxed at a personal rate.
Non-arms-length transfers can be dangerous for a number of other reasons. For example, if you accept a gift from a family member, you can become responsible for the tax debts of the gift-giver. This means that you could hold joint responsibility for the tax debt of a family member. In these cases, the CRA will send you a letter indicating that you are responsible for the taxes of the debtor.
This same situation could apply to a corporation. If a corporation owes tax debt and still pays its shareholders a dividend, these shareholders could become responsible for the debt if the individual, or the individual combined with his or her family members, have a controlling share of the corporation.
In addition, the loan to a shareholder or a non-arms-length individual by a corporation could have tax implications for the individual. In general, shareholder loans must be repaid to the corporation within one year or the loan will be considered income. These rules are in place to prevent corporations and shareholders from avoiding paying income tax.
If you are in a situation where you are responsible for tax debt or hold other responsibilities due to being a shareholder of a corporation and you wish to transfer or sell these shares, please contact Tax Solutions Canada today at 1-888-868-1400 to see how this non-arms-length transaction could affect you.