Van Boekel – a review of issues in attributing corporate income in Guidelines income determinations
When it comes to contentious issues encountered in a Guidelines income determination, Van Boekel v. Van Boekel, 2020 ONSC 5265 is a recent decision that analyzes several, which include:
- Attribution of corporate income from a highly cyclical business subject to losses;
- Whether financial covenants on a bank loan constrained the availability of income from the payor-spouse’s corporation;
- Whether a money-losing venture was really a ‘business’ or merely an expensive hobby;
- Applicability of tax gross-ups;
- Inclusion of capital dividends; and
- Potential imputation of income to a payor-spouse who managed – without pay – a business owned 100% by his mother.
The decision was written in a colourful narrative and the case included a payor-spouse who had previously been jailed for repeated hog manure spills from his two pig farms. Bottom line: it’s a fun read for family lawyers and financial experts alike.
When a money-losing venture becomes a hobby
In this case, the company owned by the husband (as the payor-spouse) burned through a total of $3.9 million in losses relating to a cutting horse operation from 2001 to 2018. The cutting horse business was ancillary to the husband’s primary business of hog farming. While the husband argued that these were legitimate business losses, he acknowledged that the cutting horse operation had begun as a hobby. The wife countered that “the best way to become a millionaire in the horse business is to start with two million”. The judge appears to have agreed with her and noted that where a business loses money in 17 of its 18 years of operations, there is clearly no reasonable expectation of a profit and that this ‘business’ is really a ‘hobby’.
As a result, in determining the husband’s income, the judge considered the cutting horse losses to be “available” income from the corporation. (This is similar to the concept of a personal expense, but with an important distinction discussed below.)
Tax gross-ups
With respect to the losses from the cutting horse ‘business’, the husband’s CBV did not apply a tax gross-up, while the wife’s CBV did. Ultimately, the judge followed the logic in a precedent case and did not apply a gross-up on these losses. The judge noted that there is a difference between disregarding a corporate expense and grossing up a personal expense paid by a corporation. The judge reasoned that “I am not discounting those expenses because they are personal expenses … Instead, I am discounting them because they are unreasonable corporate expenses”. Reading between the lines, the judge seems to make a distinction between a true ‘personal expense’ – vs. an expense arising from a poor business decision – when assessing whether or not it is appropriate to apply a tax gross-up to an expense.
Attributing pre-tax corporate income when there is none
Given that the pork farming business is highly cyclical, the husband’s hog farming corporation (“Hog Farms”) generated substantial income in some years and losses in others. The judge in this case upheld previous precedent that no corporate income may be attributed to a payor-spouse in years when the corporation suffers a loss.
The impact of bank covenants
The husband’s company was subject to a number of financial covenants, including an annual cap on distributions to shareholders of $150,000. In the years where the available pre-tax income from the company exceeded $150,000, the husband’s expert took the position that the theoretical amount available to the husband under Section 18(1)(a) of the Guidelines was, therefore, $150,000.
This decision articulated the court’s views with respect to the impact of bank covenants in a Guidelines income determination, which established two key principles:
Bank covenants may be irrelevant if they have never actually been enforced by lenders historically. In this case, Hog Farms had breached numerous separate financial covenants across multiple years, but its lender never called the loan due to these breaches. Moreover, the company’s lender was well aware of the husband’s need for cash to fund ongoing support obligations. Accordingly, the judge ruled that the bank covenants were “not an impediment” from the husband making support payments.
In assessing the impact of bank covenants, the court is not obliged to consider the impact of income deemed “available” under Section 18(1)(a) as if it had been withdrawn. The husband’s expert took the position that, if a business generated $500,000 in “available” pre-tax corporate income under Section 18, the husband would have actually had to have withdrawn that income in order to make support payments on it, and that this withdrawal would have caused a breach in financial covenants (thereby rendering it “unavailable”). The judge in this case ruled that argument to be “non-sensical” and pointed out that the payor-spouse could simply leave the income in the corporation and take it out at a later date. More bluntly, the judge ruled that “The whole point of the attribution exercise in s. 18(1) of the Guidelines is to impute corporate income to the payor that was never actually taken out of the corporation.”
Capital dividends
In this case, the payor-spouse declared $1.2 million in capital dividends in 2017 that were used to offset an amount owing from him to his corporation. The capital dividend account balance from which the capital dividends were declared related to the sale of two farms in 2012 and 2013.
The judge excluded the capital dividends from the husband’s income because:
- The origin of the capital dividend account balance was a non-recurring gain (the judge deemed sale of the farms to be non-recurring events).
- Since the capital dividend was not actually paid to the husband, the declaration of the capital dividend “did not create any available cash or disposable income, it simply provided the [husband] with a means to withdraw cash out of the corporation on a tax-free basis when and if it is available”.
Potential attribution of income from a business owned by the mother of the payor-spouse
The husband was the general manager of a company (“Holdings”) which was 100% owned by his mother and which was also involved in the hog business. The payor-spouse did not receive any compensation for this role. Opposing counsel argued that, by providing free services to Holdings, the husband was effectively increasing the retained earnings of Holdings – a company that he was presumed to eventually inherit – and that a market rate of compensation should be attributed to him.
While the judge agreed that this would likely benefit the husband in the long run, he ruled that there is no basis at law to impute income to him from Holdings, since:
- The husband was not a shareholder, director, or officer of Holdings under Section 18(1) of the Guidelines.
- Even if he were, Holdings lost money in four of the five most recent years; the court had already concluded that no corporate income may be attributed to a payor-spouse in years when a corporation suffers a loss (as discussed above).
Summary
A common concern when assessing the availability of corporate income in a Guidelines income determination is to not attribute too much income to the payor-spouse such that it “kills the goose that lays the golden eggs”. This case was more about cutting horses that, financially speaking, almost killed the hogs.
While there were a number of other legal issues discussed in this decision, Van Boekel provides lawyers and financial experts a recent and thorough analysis of several nuances in calculating available income under the Guidelines. It cites a number of important precedents related to Guidelines income calculations, and I expect that it will be cited and referenced by both lawyers and financial experts in the future.
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