Courts look more carefully at remaining pre-tax income in a corporation controlled by a support payor
The economic effect of the pandemic on Canadians has resulted in a significant drop in income across many industries, resulting in courts looking more carefully at remaining pre-tax income in a society controlled by a support payer.
In Canada, child and spousal support are determined on the basis of income, and the Child Support Guidelines prescribe how the payor’s income is to be determined for the purposes of paying child support and support. joint. Determining the income of a support payor who is a T-4 employee is straightforward, but it becomes more complicated for those who are self-employed and earn income through a corporation they control.
The guidelines state that child support should vary each year, depending on how the payor’s income has changed over the past year. Usually, the parties exchange their tax returns to determine the amount of the change. Not surprisingly, when a payer runs a business through a company they control, the annual change is honored more in violation than in compliance. In these cases, the guidelines require that if the total income reported on the payor’s personal tax return is not the best indicator of income, the court may consider a number of other factors, including the expenses the payor shareholder/payer deducted within the corporation and the pre-tax profit that may remain in the corporation from year to year.
During the pandemic, despite applying the same provisions of the guidelines, courts have come to different conclusions, particularly when dealing with a situation where pre-tax profits remain in the company.
In two decisions of the Ontario Superior Court of Justice — one a trial decision by Justice Llana Nakonechny, heard in December 2020, and the other, an interim decision by Justice Jessica Kimmel, heard in February 2021 — the two judges examined the effect of the pandemic and the reasons given by each shareholder as to why pre-tax corporate profit should remain in the company, rather than being withdrawn, in part or in full, as income from which child and spousal support would be paid.
In each case, the judge had to decide whether to allocate none, some, or all of the pre-tax earnings withheld in the corporation to the shareholder’s personal income for support purposes.
In Nani v. Nani, the husband had a successful property management and property ownership business. Prior to the separation, the family had a luxurious lifestyle and the wife asked the court to determine that the husband’s income was $653,000 per year, while he stated that his income for alimony purposes was $440,000. The dispute centered on whether the pre-tax earnings of the corporation should be added to the husband’s income.
To decide the issue, Kimmel acknowledged that she had to consider the historical pattern of how retained earnings had been treated, the industry in which the company operated, the husband’s business plans, the level of debt of the business, financing and any other debt restrictions, whether wages were at market or otherwise, and whether there were legitimate business reasons to retain pre-tax profits in the business.
Nakonechny also applied the same type of pre-tax income test in Nersisian v. Hyde, where an employment lawyer who started his own firm about a year before the pandemic had pre-tax income. in his professional society. .
The effect of COVID-19 was considered by both judges. Kimmel reviewed cash risks arising from the pandemic, which included the prospect of customer terminations or breaches of contract, possible collection issues, as well as payroll and other operating expenses that are expected to be paid whether or not the customers are in default or terminated. their facilities.
Nakonechny examined the lawyer’s fledgling employment business’s level of cash, the need for capital expenditures, the important work that had arisen as a result of employment issues that arose during the pandemic, and whether if work would continue at the same pace, increased spending for more staff and office space, and the company was only a year old.
In both cases, the court added about half of the pre-tax earnings to income for support purposes. There is little doubt from reading the reasons that each judge exercised caution due to the pandemic.
Kimmel noted that the court must carefully consider where and how additional money could be found from a corporation’s pre-tax income to fund support, and cited a previous case saying, “the failure to not fully understanding this question” can lead to an incorrect result and in the end, if the parent cannot come up with the expected extra money… (this) can undermine the functioning of society and possibly kill the egg hen Golden. ‘”
In Leggett v. Leggett, a September 2020 decision by B.C. Supreme Court Justice Alan Ross, the court considered whether to include pre-tax earnings from a husband-owned design business. The husband indicated that given the possible slowdown resulting from COVID-19, he was unsure whether he could continue to maintain his salary from his business and that he had reduced his income in June and July due to a decrease in work. At issue was whether his salary as well as his company’s pre-tax earnings should be taken into account in determining spousal support on an interim basis.
Without reference to any evidence on the state of the husband’s business or the industry, Ross said, “I can’t make any predictions for the economy in general. However, it is evident that the economic shutdown in this province was most severe during the month of April to July. Economic activity has increased since the summer. Therefore, I attach little importance to Mr. Leggett’s fear of not being able to maintain (his) income… Subject to a further shutdown of the economy due to the pandemic, he there is no reason to believe that his overall income…will be diminished.”
Ross said he wouldn’t predict, but it looks like he did. He calculated the husband’s income as his management income for the previous year plus the entirety of his corporation’s pre-tax income at the end of the year and ordered spousal support based on that income.
Any shareholder who wishes to operate their business prudently in these uncertain times and retain retained earnings in their company must present a clear business case to do so. Failure to do so will likely result in an increase, rather than a decrease, in pre-tax income included in income for support purposes.
This article originally appeared in The Financial Post.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.