With the top marginal personal tax rate exceeding 50 per cent in more than half the provinces in Canada, it’s no surprise that some taxpayers are looking at ways to income split with a spouse or common-law partner. In a province like Ontario, where the top marginal tax rate is 53.5 per cent and the bottom rate is 20 per cent, that’s a spread of over 33 per cent.
There are a variety of ways to legally split your income with a spouse. They range from straightforward strategies, like pension income splitting or CPP/QPP sharing, to more sophisticated strategies such as using a prescribed rate spousal loan to have any excess returns above the prescribed interest rate (currently holding at two per cent) taxed in the hands of the lower-income spouse.
But perhaps the most common method I’ve seen couples employ in their attempt to income split is for one of them to “hire” their spouse or partner to either work in their business or, if they’re an employee, become their personal assistant. While this can be a tax-effective strategy when it involves legitimate work and appropriate pay, the Canada Revenue Agency takes a dim view of questionable spousal employment arrangements, as one taxpayer recently found out in a Tax Court decision released this week.
Before going over the facts of the case, let’s review the tax rules governing when an employee can hire, pay for, and deduct the cost of an assistant as a legitimate employment expense.
Under the Income Tax Act, an employee is permitted to deduct any “salary” paid to an assistant provided their employment contract “required” the employee to incur the expense and this is certified by the employer on CRA Form T2200, “Declaration of Conditions of Employment.” Where an expense is not explicitly required to be incurred by an employee in their employment contract, it may still be deductible if it’s found to be an implied requirement. In making this determination, the courts have reviewed whether the failure to meet this requirement could result in the employee’s termination, a poor performance evaluation or other disciplinary action on the part of the employer.
The recent tax case involved an individual who was employed as the Canadian manager of a large, multinational manufacturer of dental instruments and products, with headquarters in Chicago. Her job was to oversee the Canadian sales force and operations. Since the company didn’t have a Canadian office, she was required to travel extensively throughout the year to meet with sales representatives, dealers and customers throughout Canada. She spent 80 per cent of her time away from her home office.
In 2015, she reported employment income of just under $200,000. Against this income, she deducted over $80,000 of employment expenses, nearly half of which were amounts paid to her husband, who acted as her assistant. The CRA denied the expense.
The court was shown a copy of the taxpayer’s Form T2200, duly-signed by her employer, which stated that she was required to incur expenses for her travel throughout Canada. Question 9 of the Form asks, “Did this employee’s contract of employment require them to … employ a substitute or assistant?” The answer on the T2200 for 2015 was “Yes.”
But the court was also shown a copy of the 2012 T2200, which was accompanied by a letter from the corporate controller. That letter stated that if the taxpayer “believes she requires an administrator or other assistance to perform her duties, this is her decision. We do not, as company policy, fund the expense of engaging an assistant.” The T2200 was amended to reflect the fact that the taxpayer employed someone to assist her with her job duties. The answer to Question 9 was changed from “No” to “Yes.”
The judge had a number of concerns with deductibility of the assistant. To begin with, the taxpayer testified that she required her husband’s services because “she did not have any formal schooling or training.” The judge found this odd because nearly all the categories of services he provided were clerical, administrative, secretarial or involved driving. The judge also felt that, based on the letter from the controller, the taxpayer was not actually “required” to hire an assistant but rather it was her decision to do so, if she felt it was necessary.
Next, while the Income Tax Act permits a deduction for amounts paid to an assistant if that payment was required by the taxpayer’s contract of employment, the payment must be in the form of a salary. Prior jurisprudence found that the use of the word “salary” only contemplates payments made by an employer to an employee. It turns out that her husband was paid as an independent contractor who invoiced her an hourly fee for his services. He reported this as professional income on his own tax return and even charged his wife HST on his services. No source deductions for income tax, CPP or EI were withheld.
Another problem was that the taxpayer never actually paid the amounts to her husband. The couple simply had a single joint bank account from which either could withdraw funds and to which either could make deposits. “That is not considered payment in normal circumstances,” remarked the judge.
The judge also questioned both the quantum of the hours her husband worked and the reasonability of his hourly wage. The husband could not reconcile the hours he charged in 2015 with the hours he set out in his quarterly accounting and billing to his wife. Indeed, he could only account for a very small fraction of the hours charged from his monthly records. Additionally, the judge was not convinced that the “activities performed by (the husband) at an hourly rate of $75 for clerical, secretarial and Excel/Powerpoint presentations prepared from information and data from (his wife) … and driving her to and from the airport is anywhere close to the range of reasonable.”
For all these reasons, the judge disallowed the entire expense associated with the hiring of the taxpayer’s husband as her assistant.