Introduction

First, a warning. income tax laws can change fast, albeit rarely, but sometimes, the changes are announced in a federal budget one night, and implemented the next day. So beware that parts of what you are about to read may become obsolete faster than I can change the content!

In any event, tax law is like a minefield. Common sense does not always prevail; a policy of taxation and collection does.

Further, officers of Canada Revenue Agency (CRA) can act like tax pitbulls, barking and biting first, seeking judicial approval later.

This makes it hard to give legal advice because defying CRA is not usually a good idea except for the very deep pocket tax-payer. Once CRA has you on their radar screen, audits, challenges etc. can all be brought to bear and have you waving the white flag in no time, law be damned.

Not all lawyers are versant in income tax matters so be on guard. Knowledge of tax law can be essential. For example, a lump sum support payment is generally not a tax deduction for the payor. However, if the payment is structured or worded a certain way within a separation agreement or consent order, it may qualify as a tax deduction for the payor. Hence those golden words: seek legal advice!

Finally, this article does not cover the tax implications of matrimonial property divisions. Please refer to the numerous references at the end of this article for more information on those and other related topics.

Child Support

It is of great but diminishing interest for child support payors and recipients to know whether or not the child support they receive, or pay, is taxable income, or whether their payments can reduce their taxable income.

Child support payments made pursuant to a court order or a written agreement dated or subsequent to May 1, 1997 are not taxable in the hands of the recipient and the payor cannot use the payments to reduce his taxable income (i.e. they are no longer eligible deductions to his taxable income).

Less and less relevant is the rule of tax law that child support payments made pursuant to a Court order or a written agreement prior to the cut-off date of May 1, 1997 are taxable to the recipient and deductible to the payor, although the parties may opt-in to the new regime.

This is obviously a significant factor to keep in mind in deciding whether or not to vary a pre-May 1997 order or agreement as doing so may well place the payor in a disadvantageous tax situation as he’ll then lose his deduction. Conversely, such a variation would enhance the recipient’s as she will thereafter receive child support as tax free income.

The amount of a lump sum payment of support, in any event, is not an eligible tax deduction.

Spousal Support

Generally, spousal support is taxable to the recipient, and a tax deduction to the payor. For this reason, lawyers acting for the payor and who are negotiating consent orders or separation agreements will often try to qualify as much of the support payments as possible as spousal support, instead of child support as the payor can use the payments to reduce his taxable income.

CRA is alive to this and have taken it upon themselves to review the agreement or order and to make a determination, based on whatever facts they choose as material, and reallocate support from spousal to child support. Toronto family law expert John Syrtash wrote a scathing article on this practice in the Lawyers Weekly of February 15, 2008 noting that CRA requires, with no basis in law, written receipts for the alleged spousal support failing which, the payor loses his deduction. Syrtash describes it as:

""... this unwritten rule magically created by certain CRA officials without legislative authority.....

The CRA have ... recently decided to ignore particular court orders – those that specifically characterize periodic support payments as spousal support...."

Given the financial significance of the deduction to the payor, he reasonably suggests adding a strict term in a separation agreement or consent order to the effect of obliging the recipient o provide the payor with an annual receipt, failing which support payments cease.

To be fair, CRA works for all Canadians and is always on the lookout for tax evasion. One way to break the law would be for two persons to allege a common law relationship and then write a sham separation agreement in which one pays the other a substantial spousal support award. The recipient fraudulently returns the money to the payor on the sly, perhaps for some nominal amount, and the payor benefits from a substantial tax deduction.

It is for these type of people that CRA likely feels that it needs some flexibility in individual cases.

The Income Tax Act, at s. 248, defines a common law partner as:

"... with respect to a taxpayer at any time, means a person who cohabits at that time in a conjugal relationship with the taxpayer and (a) has so cohabited with the taxpayer for a continuous period of at least one year, or (b) would be the parent of a child of whom the taxpayer is a parent..."

Legal Fees

According to CRA’s Interpretation Bulletin IT-99R5:

"Legal costs incurred in establishing the right to spousal support amounts, such as the costs of obtaining a divorce, a support order for spousal support under the Divorce Act or a separation agreement, are not deductible as these costs are on account of capital or are personal or living expenses. However, since children have a pre-existing right, arising from legislation, to support or maintenance, legal costs to obtain an order for child support are deductible. Legal costs of seeking to obtain an increase in spousal or child support, or to make child support non taxable under the Federal Child Support Guidelines, are non-deductible.

 

"Legal costs incurred to enforce pre-existing rights to interim or permanent support amounts are deductible. A pre-existing right to a support amount can arise from a written agreement, a court order or legislation ... In addition, legal expenses incurred to defend against the reduction of support payments are deductible since the expenses do not create any new rights to income.

"

 

 Legal fees incurred to establish an obligation of child or spousal support are not deductible from income but, where they have been incurred to enforce or defend an existing child or spousal support obligation, they are deductible.

In McColl, Justice Hamlyn held that Heather McColl’s legal expenses were deductible:

"All the legal expenses were incurred to determine her husband's income who was, as admitted, the father of her son. The legal expenses were to enforce a pre-existing right to a support amount as provided by law.

"The legal expenses incurred were considerable as the Appellant had to expose and demonstrate the father's ability to pay. The Appellant eventually succeeded in negotiating the aforementioned separation agreement.

"Legal costs to establish a right to support amounts (spousal or child) are non-deductible because they are costs on account of capital or are personal or living expenses, but legal costs incurred to enforce a pre-existing right to either interim or permanent support (spousal or child) are deductible.

"In this case, the Appellant incurred $10,949.89 in legal expenses to enforce the pre-existing legal right to support by quantifying the amount for the child. While the Appellant did obtain a personal benefit from the expenses, that personal benefit did not diminish the totality of the legal expenditure to enforce the same pre-existing right of the child to a support payment.
"

Legal fees spent for divorce, custody or guardianship rights are not deductible.

REFERENCES:

  • Canada Revenue Agency, Interpretation Bulletin (IT) on Support Payments (IT-530R, dated January 11, 1999), available as of September 2008 at http://www.cra-arc.gc.ca/E/pub/tp/it530r/it530r-e.html
  • Canada Revenue Agency Interpretation Bulletin IT-99R5 "Legal and Accounting Fees", published as of September 2008 as of http://www.cra-arc.gc.ca/E/pub/tp/it99r5-consolid/it99r5-consolid-e.html (¶17-21 on "Support Amounts").
  • Canada Revenue Agency Guide P102: Support Payments, published as of September 2008 at http://www.cra-arc.gc.ca/E/pub/tg/p102/README.html
  • Cole, S. and Freedman, A., Property Valuation and Income Tax Implications of Marital Dissolution (Toronto: Carswell, 1999).
  • Continuing Legal Education Society of British Columbia, Tax Issues for Litigators (October 2000)
  • Duhaime, Lloyd, How Not To Manage a Bankruptcy or Income Tax Case, published at www.duhaime.org/LegalResources/CivilLitigation/LawArticle-186/How-Not-To-Manage-a-Bankruptcy-or-Income-Tax-Case.aspx
  • Freedman, A. and White, P., Financial Principles of Family Law (Toronto: Carswell, 2008).
  • Huot, R., Understanding Income Tax For Practitioners (2000-2001 edition).
  • Income Tax Act, Revised Statutes of Canada, 1985, Chapter 1 (5th Supplement), published at http://www.canlii.com/ca/sta/i-3.3/
  • McColl v R 6 RFL 5th 353, published at http://www.canlii.org/en/ca/tcc/doc/2000/2000canlii363/2000canlii363.html
  • Sherman, David, Basic Tax and GST Guide For Lawyers (Toronto: Thomson-Carswell, 2005).
  • Syrtash, John, "Taxation of Support Payments: Approach With Caution", The Lawyers Weekly, Volume 27, No. 38, February 15, 2008, page 8 and 10.