Child Support: Attributing Pre-Tax Corporate Income to Shareholder Parents
For Canadian courts, the exercise of setting the amount of child support payable by separated or divorced parents is a complex one at the best of times. The calculation essentially starts by determining the parent’s income, but even that simple step can get quickly complicated when the paying parent is a shareholder, officer or director of a corporation. This is because corporate models allow for the discretionary retention of corporate earnings and some flexibility in otherwise legitimate decisions; these can be structured to effectively “shelter” a part of the income on which the shareholder parent’s child support obligations would otherwise be based.
In light of that possibility, s. 18 of the federal Child Support Guidelines grants a court the discretion to consider the “pre-tax income of the corporation … for the most recent tax year” in attributing income to that parent, in situations where the court concludes his or her declared income “does not fairly reflect all money available to the parent or spouse for the payment of child support”.
This discretion to scrutinize a corporation’s pre-tax income, including retained earnings, allows a court to more accurately assess income and identify money that should be available to the children of shareholders and officers/directors after dissolution of their parents’ relationship, while still acknowledging the realities of business. As the court in Koester v. Koester, 2003 CanLII 2150 (ON SC) described it (at para. 35):
As I see it s. 18 of the Federal Child Support Guidelines is designed to address the unfairness which would result if a spouse was to artificially manipulate his income through a corporate structure for the purpose of avoiding child support obligations. The use of the word “may” makes it clear that this is a discretionary tool. The use of the word “fairly” denotes recognition that corporations and businesses must operate in the real world and that there may be valid and legitimate business reasons for maintaining retained earnings in a corporation and not making them available to shareholder owners, either by way of salary or dividend. …
As a procedural aside, it should be noted that a parent’s intent to avoid child support is not a prerequisite for a court to exercise its discretion in this regard. (Domik v. Ronco, 2013 ONCJ 197, 2013 CarswellOnt 4448). Also, “pre-tax corporate income”, as referred to in s. 18 of the Guidelines, and “retained earnings” are not exactly the same thing. Nor are retained corporate earnings to be considered the same as cash in a bank account (see Bembridge v. Bembridge, 2009 NSSC 158, 2009 CarswellNS 450, 278 N.S.R. (2d) 209, 73 R.F.L. (6th) 147, 886 A.P.R. 209).
In any case, the court’s assessment of whether all or a portion of a corporation’s pre-tax income should be attributed to a parent’s income will involve consideration of a very broad list of factors, including the nature of the corporate business and its history. According to the decision in Brophy v. Brophy, (2002),  O.J. No. 3658, 32 R.F.L. (5th) 1 (S.C.J.) – and endorsed most recently in Woodruff v. Howard, 2014 ONSC 5723 (S.C.J.) – there are a number of principles and factors as being relevant to the determination. The court must consider:
- Whether, because of the separate legal entity of the corporation, the court should be generally reluctant to automatically attribute corporate income to the shareholder;
- Whether there a business reason for retaining earnings in the company;
- If there is only one principle shareholder, or whether there are other bona fides arm’s length shareholders involved;
- The historical practice of the corporation for retaining earnings;
- The degree of control is exercised by the spouse over the corporation.
Courts have applied these factors in many subsequent cases and in many different contexts, and the guiding list has been recently expanded and summarized in Thompson v. Thompson, 2013 ONSC 5500, where the court at para. 92 identified the following criteria:
- The historical pattern of the corporation for retained earnings.
- The restrictions on the corporation’s business, including the amount and cost of capital equipment that the company requires.
- The type of industry the corporation is involved in, and the environment in which it operates.
- The potential for business growth or contraction.
- Whether the company is still in its early development stage and needs to establish a capital structure to survive and growth. [sic]
- Whether there are plans for expansion and growth, and whether the company has in the past funded such expansion by means of retained earnings or through financing.
- The level of the company’s debt.
- How the company obtains it financing and whether there are banking or financing restrictions.
- The degree of control exercised by the party over the corporation, and the extent if any to which the availability of access to pre-tax corporate income is restricted by the ownership structure.
- Whether the company’s pre-tax corporate income and retained earnings levels are a reflection of the fact that it is sustained primarily by contributions from another related company.
- Whether the amounts taken out of the company by way of salary or otherwise are commensurate with industry standards.
- Whether there are legitimate business reasons for retaining earnings in the company. Monies which are required to maintain the value of the business as a going concern will not be considered available for support purposes. Examples of business reasons which the courts have accepted as legitimate include the following:
- The need to acquire or replace inventory;
- Debt-financing requirements;
- Carrying accounts receivable for a significant period of time;
- Cyclical peaks or valleys in cash flow;
- Allowances for bad debts;
- Allowances for anticipated business losses or extraordinary expenditures; and
- Capital acquisitions.
Once a court sees fit to attribute pre-tax corporate income in this manner, it also has discretion to determine the extent to which any retained earnings are to be included, depending on the individual facts of the case (see for example Kowalewich v. Kowalewich (2001), 19 R.F.L. (5th) 330 (B.C. C.A.); Tauber v. Tauber (2001), 18 R.F.L. (5th) 384 (Ont. S.C.J.); Blackburn v. Elmitt (1997), 34 R.F.L. (4th) 183 (B.C. S.C. [In Chambers]); Westworth v. Westworth (1999), 1 R.F.L. (5th) 186 (Alta. C.A.)). The onus remains on the paying shareholder-parent to show why retained earnings should not be attributed to pre-tax corporate income (see Bembridge v. Bembridge, 2009 NSSC 158, 2009 CarswellNS 450, 278 N.S.R. (2d) 209, 73 R.F.L. (6th) 147, 886 A.P.R. 209), although some recent cases suggest that the recipient spouse must also provide the court with some rationale for why it should exercise its discretion under s. 18 (Thompson v. Thompson, 2013 ONSC 5500, 2013 CarswellOnt 12392 (S.C.J.).
The many Canadian cases that apply s. 18 are hard to generalize; however if there is no legitimate business reason to leave funds in a company, and where retained earnings have historically been withdrawn and the paying parent in the sole shareholder, then a court will usually declare that corporate pre-tax income is to be included in the paying parent’s income, thus making it available for child support (Domik v. Ronco, 2013 ONCJ 197, 2013 CarswellOnt 4448; Bruzas v. Bruzas, 2005 CarswellOnt 4945, 20 R.F.L. (6th) 35 (S.C.J.)). This outcome is all the more likely if the release of retained earnings to the paying parent still allows for the corporation to continue its prudent business practices (Jeffrey v. Motherwell, 2006 BCSC 140, 2006 CarswellBC 211, 36 R.F.L. (6th) 377 (In Chambers)). On the other hand, a court may be more reluctant to attribute income where retained earnings have not been historically removed (Bedi v. Bedi, 2004 CarswellOnt 2102, 13 R.F.L. (6th) 40 (S.C.J.)) or where the paying parent is not the sole shareholder of the company (Ramsay v. Mackintosh, 2013 ABQB 80, 33 R.F.L. (7th) 81)).
Quantifying the precise dollar-figure to be attributed to income will also involve many considerations. Although a court may invite the input of the shareholder-parent in this regard, it may decide to take out more retained earnings than suggested if there is no evidence of harm to the corporation (Pollitt v. Pollitt, 2010 ONSC 1617, 3 R.F.L. (7th) 1 (S.C.J.); additional reasons 2011 ONSC 1186, 2011 CarswellOnt 1219, 3 R.F.L. (7th) 127 (S.C.J.); additional reasons 2011 ONSC 3107, 2011 CarswellOnt 2286 (S.C.J.); additional reasons 2011 ONSC 3162, 2011 CarswellOnt 5873, 3 R.F.L. (7th) 151 (S.C.J.). It may also assess whether various ostensible corporate deductions (such as the cost to purchase luxury vehicles) are truly necessary for running a business, particularly if the parties’ lifestyle suggests that they are living beyond what their declared income would otherwise allow (Turk v. Turk, 2008 CarswellOnt 512, 50 R.F.L. (6th) 211 (S.C.J.)). However, in keeping with the express wording of s. 18, the court must remain mindful to limit its evaluation to the corporate pre-tax income for the most recent tax year only (Chapman v. Summer (2007), 2007 BCCA 103, 37 R.F.L. (6th) 122; varying 2005 BCSC 1359 (S.C.)).
Finally, it is important to point out that whatever a court may conclude on whether and to what extent retained earnings should be attributed, the ramifications are confined to merely calculating child support and the paying parent’s notional income; it does not affect the corporation’s real-life financial dealings and there is no requirement that the retained earnings must be actually be paid out to the shareholder-parent (Mercer v. Rosenau, 2013 NLTD(F) 18; leave to appeal refused 2013 NLCA 64).
Section 18 of the Child Support Guidelines is an important statutory mechanism by which courts can inject some real-world practicality into the assessment of a parent’s available income for child support purposes. Its use by courts recognizes certain legitimate corporate objectives, but still ensures that the children of corporate shareholders, officers or directors receive the full amount of support to which they are entitled.