Shareholder disputes and taxes: resolving fights over corporate tax debts

When the tax authorities come knocking on a corporation's door, shareholder disputes often follow. While this can be very stressful for everyone involved, the law offers several tools that shareholders and corporations can use to address them.

In this article, we will discuss shareholder disputes over corporate tax liabilities and the legal remedies available. For factspecific advice beyond this overview, consulting a Lexpert-ranked corporate tax lawyer is advisable.

What are shareholder disputes over corporate tax liabilities?

From disagreements over shareholder rights to disputes about corporate tax liabilities, shareholder disputes can take many forms. In Canada, shareholder disputes over corporate tax liabilities often arise when owners disagree over who should bear unexpected tax bills that the Canada Revenue Agency (CRA) says are still owing.

How disputes over corporate tax liabilities start

Usually, your corporation may have filed its returns and paid what it believed was the right amount of tax. Years later, the CRA will reassess an earlier year and increase the tax. By then, your corporation may have already paid cash to its shareholders through dividends or other transfers, and may not have enough assets left to cover the new assessment.

Where Section 160 of the ITA matters

At that point, Section 160 of the Income Tax Act (ITA) becomes critical. It states that the CRA can then turn to certain shareholders and other related parties who received property from the taxdebtor at less than fair market value in a nonarm's length transaction. This includes:

• shareholders who received dividends from a company they do not deal with at arm's length, or
• a corporation they control through a holding company

That is often where disputes begin, since the shareholders may have assumed that their liability has ended with the amount they paid for their shares. However, Section 160 can make a nonarm's length transferee jointly and severally liable for a part or all the transferor's unpaid tax at the time of the transfer, up to the value shortfall on the property moved.

The rule covers any "transfer of property," which is interpreted very broadly. For instance, cash dividends from a taxdebtor corporation to related shareholders can count as a transfer of property.

You can learn more about your corporation's tax liabilities with this video:

Reach out to any of the best corporate tax lawyers in Canada as ranked by Lexpert if you have questions on how to resolve shareholder disputes in your company over its tax liabilities.

Strict liability under ITA's Section 160

Here are the effects when the law says that Section 160 is a strict liability provision:

• Due diligence is not a defence: It does not matter whether your corporation's shareholders knew about the tax debt or intended to help anyone avoid the tax. This means that due diligence is not a defence for these shareholders
• Section 160's broad applicability: Once a reassessment has increased the corporation's tax for the year in question, the CRA can apply Section 160 even after many years since the original transfer. The shareholder can be assessed even if the corporation has since become insolvent or been sold

This legal reality often clashes with what your shareholders expected when they accepted the dividends or other transfers.

What laws govern shareholder disputes over corporate tax liabilities?

Let's break down these two to better understand the laws governing shareholder disputes over corporate tax liabilities: first, we'll look at the corporate laws surrounding these disputes, then we'll discuss briefly the tax laws that govern corporate tax liabilities.

Corporate laws on shareholder disputes

There are two levels of corporate laws regarding disputes among shareholders, depending on how it was incorporated and where it is located:

• the Canada Business Corporations Act (CBCA), the federal statute on corporations
• provincial corporation laws, such as the Business Corporations Act of Ontario

Identifying which corporate statute applies to your corporation is important, because it affects how the corporation should address shareholder disputes.

Matters covered by corporate laws

These corporate statutes also govern the following matters:

• how shareholders' meetings are called and how resolutions are passed, which is relevant when resolving internal disputes within the corporation
• appraisal rights, which is when shareholders can dissent from fundamental changes and require the corporation to buy back their shares at fair value
• how unanimous shareholder agreements can shift powers of the directors to the shareholders, and in turn impose directorlike duties and liabilities on those shareholders

These rules matter in taxrelated disputes in corporations, because they define who had control, who made dividend and distribution decisions, and what rights each shareholder has when issues arise.

Rights of minority shareholders

One of the contentious areas when it comes to disputes among shareholders is the rights of minority shareholders. They are often the ones raising concerns about problems in the corporation, and the law protects them when they do so.

In addition, minority shareholders can also use the oppression remedy (as discussed below), and other remedies to resolve disputes with the majority, such as dissent and appraisal rights.

Tax laws on corporate tax liabilities

A second legal layer in shareholder disputes involves tax law. These laws start where a corporation is treated as a separate "person" for income tax purposes, must file its own corporate tax returns, reports its own income, and is primarily responsible for paying its own tax bill under the ITA.

How can shareholder disputes over corporate tax liabilities be resolved?

There are several steps that your corporation can take to prevent and address shareholder disputes as they arise. With the help of your corporate lawyer, here are some of these ways, whether it is for corporate tax liabilities or other similar causes.

Having a good shareholder agreement

Since prevention is better than cure, your corporation must treat shareholder agreements as one of the best preventive measures from shareholder disputes. Here are the considerations when drafting shareholder agreements:

• the decision-making processes of the corporation, and the specific decisions which require unanimous approval from the board and/or shareholders
• the process for shareholders who want to exit the corporation, including the grounds and timelines when they want to get out or if the corporation wants to remove them
• the internal dispute resolution processes, which may include both alternative dispute resolution methods (e.g., mediation, arbitration)

In disputes among shareholders involving corporate taxes, parties will look first at the shareholder agreement to see how tax risk, information rights, and exit routes were allocated. Courts may enforce those terms directly, and when there are gaps, courts may also use other remedies, such as oppression, to fill them based on reasonable expectations.

Watch this video to learn more about these shareholder agreements:

Bookmark our Legal FAQs page for more articles addressing daily legal concerns, especially for your business or your corporation.

Filing a formal tax dispute with the CRA

Another option is to file a formal tax dispute with the CRA regarding its assessment. It's important to involve a corporate tax lawyer at this stage, given the number of procedural rules to consider, including:

• jumpstarting the process of filing your formal objection
• the deadlines and limitations when submitting your objection
• the payment of disputed amounts in the assessment

Resorting to oppression remedy

Corporate statutes also contain the oppression remedy under Canadian corporate law, a broad remedy used to protect the reasonable expectations of shareholders. Most corporations, however, treat this as a last resort, since court proceedings can be lengthy and costly.

Under Section 241 of the CBCA, the court can correct any of the following if it is oppressive or unfairly prejudicial to any of the corporation's security holder, creditor, director, or officer:

• any act or omission of the corporation or its affiliates
• the manner that the business or affairs of the corporation or its affiliates has been carried out
• the manner which the directors exercised their powers

When a Section 160 assessment happens, and a shareholder feels unfairly exposed, they may claim oppression if they believe others used control or corporate processes in a way that prejudiced their interests. The court will then look at the surrounding laws and agreements to decide whether the conduct has crossed the line into oppression or unfair prejudice.

Shareholder disputes: When tax debts lead to corporate disputes

When shareholder disputes arise over corporate tax debts, the situation can feel hard to manage. The important thing is to turn a messy fight into a structured process. This is also where legal professionals, such as corporate tax lawyers, come in. They can guide you, your corporation, and your shareholders through the different legal options, and help you choose a path that fits both the law and the realities of your business.

Subscribe to the free Lexpert newsletter for more articles on Canadian laws, such as how to resolve shareholder disputes over corporate tax liabilities.