When couples are contemplating separation or are separated, they often focus on dividing property, arranging parenting time and working out support. One topic that rarely gets attention is tax debt. Most people assume that each partner is solely responsible for their own income tax filings and any Canada Revenue Agency (CRA) debt. While that is generally true, there is an important exception in the Income Tax Act that can result in a separated partner being pursued for their spouse’s unpaid taxes. Understanding this exception can help you avoid unpleasant surprises during or after separation.
How section 160 can make you responsible for someone else’s taxes
Under Canada’s tax system each individual files and pays taxes separately. However, section 160 of the Income Tax Act allows CRA to collect a tax debtor’s unpaid income tax debts from another person if certain conditions are met. This is sometimes called “derivative tax liability.”
If the conditions are satisfied, CRA can assess the recipient for the transferor’s outstanding tax debt up to the value of the transferred property. For example, if your spouse owes $100 000 in taxes and transfers a matrimonial home worth $300 000 to you for $1, CRA could later assess you for your spouse’s tax debt up to $300 000, even if you had no knowledge of the debt.
Section 160 assessments are joint and several meaning both the original tax debtor and the transferee are liable. CRA may pursue either party for the full amount until the debt is paid. There is no time limitation, and there is no defence of due diligence or ignorance. Even if the transfer was not motivated by tax avoidance, section 160 can apply.
Why separation creates risk
During separation, spouses often restructure ownership of assets. One partner may buy out the other’s share of the home or transfer investments to equalize property. If the transferor has outstanding tax debts or a tax reassessment is issued later, those propertysettlement transactions can trigger section 160 liability. Family courts do not supervise the tax consequences of separation agreements, and CRA is not bound by agreements between spouses.
Moreover, family law courts may consider a spouse’s tax debts when dividing net family property. Although tax debt is personal, courts will sometimes treat it as “family debt” if the tax savings or business income benefitted the household. This can reduce the tax debtor’s equalization payment. However, the CRA can still pursue the other spouse if a section 160 transfer occurred.
Tips to protect yourself
If you are contemplating separation or negotiating a property settlement, consider the following:
- Request full disclosure of your spouse’s tax situation. Ask whether they have outstanding tax returns, reassessments, arrears or audits. You cannot rely on ignorance as a defence.
- Avoid transfers for nominal consideration. CRA could invoke section 160 when a spouse receives property as a gift or pays less than fair market value. In a separation agreement, ensure you pay fair value for any property you receive and document the payment (e.g., through equalization or by setoff against other assets).
- Consider indemnity provisions. Separation agreements can include clauses requiring the transferor to indemnify the recipient for any taxes assessed under section 160. While this does not bind CRA, it may give you recourse if you are assessed.
- Hold funds in trust until CRA clearance. If your spouse is under audit or owes taxes, you may agree to hold a portion of the equalization payment in trust until their tax liability is resolved.
- Obtain independent legal and tax advice. Family lawyers and tax advisers can help you structure settlements to minimize risk and ensure proper documentation.
We can help
Separation is difficult enough without unexpected tax issues. Our family law team collaborates with tax professionals to help clients navigate property settlements and avoid inadvertent tax liabilities. If you are separating and have questions about how tax debts might affect you, please contact us at [email protected] to set up a consultation.
