Child support and income tax returns can be dicey.
More to it than number on tax return: judge
For a self-employed individual, the amount of income used to determine a child-support obligation rarely mirrors the income declared on that person’s income tax return. In fact, an individual’s income tax return is just the starting point when it comes to calculating the amount of support payable by one parent to the other.
In AMW v. BW 2018, a recent case coming out of the Court of Queen’s Bench of Alberta, Justice Mah squarely addressed the impact of self-employment on the determination of income for child support purposes. In that case, the support payor, BW, owned interests in three corporations through a somewhat complex network of shareholdings with other individuals. All three corporations were engaged in the oilfield industry.
The support recipient, AMW, asserted that BW manipulated the finances of the companies to artificially reduce his income for support purposes. AMW took the position that BW’s income had been significantly understated since 2016 when the parties entered into an agreement pursuant to which BW was to pay child support of $1,104 per month for one child based on annual income of $126,540. AMW sought additional child support from 2016 based upon a proper and fulsome determination of BW’s income for support purposes. Of course, BW disagreed, taking the position that he had overpaid child support since 2016.
While Justice Mah briefly discusses the inclusion and treatment of RRSP and dividend income in determining a support obligation, the real issue in the case is the extent to which pre-tax corporate income should be attributed to BW. In other words, should the corporate income falling into BW’s corporations’ retained earnings, which are not paid out to BW, be added to his income when it comes to determining his support obligation to AMW?
According to Section 18 of the Federal Child Support Guidelines (which apply across Canada), if an individual is a shareholder, director or officer of a corporation, the court may determine that individual’s income for support purposes to include all or part of the pre-tax income of the corporation, and of any corporation that is related to that corporation. The inclusion of such income will be triggered if a court finds that the payor’s declared income does not fairly reflect all of the money available for the payment of child support.
The remedy ensures consistent treatment of parents and children who are in similar circumstances, one of the fundamental objectives of the Child Support Guidelines. Simply put, it would be unfair to permit a parent to avoid or suppress a child support obligation by way of an ability to control income through self-employment, when compared to an employed parent who has no such control.
The exercise in determining if, and the extent to which, pre-tax corporate income ought to be included in income for support purposes is complex. In the important recent decision of Halliwell v. Halliwell, 2017, coming out of Ontario’s Court of Appeal, Justice Gillese accepted the following approach.
First, acknowledge that a corporation’s retained earnings are not necessarily money that the shareholder can take out as income and that corporations have legitimate business reasons to accumulate retained earnings.
Second, a court must consider the underpinnings to the choices made by the directors and shareholders to take money out of, or leave money in, a company.
The scrutiny of these choices must be made with a discerning eye that balances factors that include sometimes complicated considerations of business viability with a payor’s duty to maximize income available for support purposes.
And finally, to properly assess a need to retain earnings for purposes of business viability, the court must look at such things as company banking covenants, economic upturns and downturns, the degree of capitalization that a particular company requires, and future growth.
Returning to AMW v. BW, the support payor asserted that the corporations’ retained earnings were necessary “due to the depressed economy and a need to maintain greater reserves for the increasing contingencies arising from a depressed economy, or other legitimate business concerns or consequences.” Justice Mah accepted BW’s position, noting “in an uncertain economy, it is prudent business practice to retain a level of earnings in the company as a hedge against falling revenues in subsequent years, thus allowing the company to meet expenses and debt repayment and thus remain in business during those lean years. Keeping the business viable in turn allows the payor to meet his child support obligations at a certain level.”
Notwithstanding this recognition, Justice Mah went on to arbitrarily attribute one-sixth of the pre-tax corporate income, net of dividends, to BW. According to Justice Mah, that approach recognized “BW’s position that the co-principals have determined that the remaining pre-tax earnings after dividends should be available for use by the corporation to remain viable during economic downturn and that BW only has one-third ownership.” In other words, Mah assessed that one-half of BW’s share of the remaining profits was available for child support purposes, even though those profits were not paid to BW.
While AMW was successful in adding some pre-tax corporate income to BW’s income for support purposes, at the end of the day, Justice Mah’s decision did not change BW’s support obligation in any meaningful way. In fact, due to other adjustments to BW’s income for support purposes, BW’s child support obligation was reduced to $993 per month.
The level of scrutiny a selfemployed individual faces in a claim for child support will likely be surprising and unpalatable. Even more disheartening will be the extent to which support may be based on income that has not been received.
SUPPORT MAY BE BASED ON INCOME THAT HAS NOT BEEN RECEIVED.