How much does my Self-Employed Spouse Really Make?
The amount of child support and spousal support (alimony) that will be ordered to pay is usually tied directly to the payor’s income, as determined by the Federal Child Support Guidelines (FCSG). Often referred to as the payor’s “Guideline Income”, the determination of this sum will trigger the specific amounts ordered to be paid by a court either under the child support tables, or the Spousal Support Advisory Guidelines. Like with most areas of family law, there are many exceptions and variables, especially with spousal support, but this is the basic approach. Whatever your situation, make sure you consult with the Best Self Employment Income Surrey Family Lawyers at Grandview Law Group LLP.
Many cases where the payor only has T4 income are straightforward. On the other hand, where the payor controls or own shares in a closely held corporation, the law has developed its own complex set of rules and principles as guided by s.18 of the FCSG. In many of these cases, you will need a professional valuation expert to determine how much of the corporation’s income to include. That topic merits its own post which one of our experienced Self Employment Income Family Lawyers will address in due course.
This current blog entry looks to briefly discuss another common scenario: where the payor is self-employed, but where the business is not itself a taxpayer, and all of his/her income flows through to the payor. This would apply, for example, in the case of a sole proprietorship and certain partnerships. In particular, we discuss the most commonly litigated issue in these situations: what expenses are reasonably deductible in determining guideline income? These calculations are of upmost importance and can have a dramatic impact on the amounts ordered to be paid.
The starting point here are sections 19(1)(g) and (2) of the FCSG which allow a court to “impute” (or add-on) income to a payor, in whatever amount “it considers appropriate in the circumstances”, where s/he “unreasonably deducts expenses from income”. With words like “appropriate” and “unreasonably”, we again are dealing with family law legislation that provides minimal direction to the court, leaving considerable judicial discretion.
An important thing to remember is that just because an item is properly expensable as a tax deduction for income tax purposes, this does not mean that those expenses can be relied upon to reduce income for the purposes of determining guideline income. In family law, a distinct analysis is required to determine whether they are “reasonable” in the context of support claims.
One deduction that is clearly addressed in the FCSG is the Capital Cost Allowance (or “Depreciation”) on real estate. Under Schedule III, these deductions will be “added back” to income. For assets other than real estate, deprecation on other property is generally allowable, subject to reasonableness. There is a well-defined body of case law – judicial decisions – laying out the factors to assess for these deductions.
How about for other categories of deductions like motor vehicle, telephone, home mortgage payments, salaries to new family members?
For the most part, the answer is “maybe”. Under the right circumstances, all categories of deductions are theoretically permissible. From the substantive legal perspective, the issue remains “reasonableness”. How these principles play out in practice, in the real world of court decisions, often comes down to the party claiming the deduction being able to fully and convincingly demonstrate and explain how it contributed to the generation of business income, and was not personal in nature. Simply having receipts for the expense and having them noted on a financial statement, and signed off on by the accountant on the income tax return will not be enough.
In our experience, the devil will be both in these details of itemized deductions, plus in the broader perspective of the overall ratio of expenses as a percentage of gross income. This may depend somewhat on the nature of the business, but where it is not known, or proven, to generate high expenses relative to income, you can expect close scrutiny where those expenses start to exceed 1/3 or so of revenues.
To a large degree, court decisions reflect the application of good old common sense, including categories like “home office expenses”. In the recent March 2017 case of J.R. v. N.R. [2017] B.C.J. No. 544, the court dealt with these expenses as follows, in a fashion that is typical for this category:
[89] There is also no evidence as to why N.R. deducted a cable/internet expense. Any cable/internet expenses are likely attached to his condo because N.R. does not have an out-of-home office, and should accordingly be calculated as part of his home office expenses, if at all. N.R.’s deducted home office expense is 25% of his total home expenses (which relate to his one-bedroom condo) and includes his electricity, insurance, mortgage interest, property taxes and strata fees. There is no evidence that N.R. requires a home office or that his home expenses are higher because of the need for a home office. While these expenses may have been properly deducted under the Income Tax Act, I do not believe they have been reasonably deducted for the purposes of determining child support. Therefore, I am adding back the entire home office and cable/internet expenses.
Another category of deduction that is often challenged is payments for services to third parties who are not at arm’s length from the payor. The classic scenario is where the payor “pays” a new spouse to perform a service that might be notionally required, but to a person who does not exactly possess the requisite skill set, and, on top of this, seems to be paying in an amount well beyond market rates.
Both of these elements were present in the 2011/2012 decisions in Clark v. Clark [2011] B.C.J. No. 1012 where the Court of Appeal upheld the trial judge disallowance of an expense paid to the payor’s new spouse. The following passage is representative of how a deduction like this will be treated for family law guideline income purposes – in this case, a $20,000 “salary” paid for “bookkeeping services”:
[86] Ms. Mercer asserts that the $20,000 salary claimed as an expense by Mr. Clark in each of 2008 and 2009 was actually paid by Mr. Clark to K. Clark and this testimony is not challenged by Mr. Clark or by K. Clark. Mr. Clark maintains that this is a necessary expense for bookkeeping services provided by K. Clark. I note, however, that Mr. Clark has an accountant – Sandra Parker – who prepares his tax returns. In any event, this is a payment to a person who is clearly not at arm’s length and the income remains in the Clark household and is therefore available for the purposes of paying child support. I conclude that the $20,000 shall be added back to Mr. Clark’s net fishing income for the purposes of determining his Guidelines income.
This does not mean that a family member can never be used to perform deductible services. In fact, in an interesting twist, the payor in the Clark case argued at the Court of Appeal that the trial judge erred in not allowing the $20,000 given that the captain of the very boat that Mr. Clark worked on had done exactly the same thing: paid his current spouse $20,000 for bookkeeping services, and that trial judge accepted the deduction! In commenting on that decision (Roberts v. Robyrts 2008 BCSC 281), the Court of Appeal noted the real benefits of the new spouse’s services. As stated by the original trial judge:
[18] …Next, she says some of the expenses claimed … for tax purposes should not be allowed for child support purposes, most particularly, the $20,000 payment to his wife for bookkeeping. The plaintiff submits that that payment is simply a device used by the defendant for income splitting, and that his wife does not provide a service worth that much to the corporation.
[19] The defendant responds that he used to have an accountant do the books for his company before he remarried, and that having his wife do the bookkeeping now actually saves the company money. He points out that his wife has an accounting background from 13 years employment with Telus and the Vancouver Port Authority. I am satisfied that the amount paid by BKR to the defendant’s wife is reasonable compensation for the service she provides.
The lesson here is clear: if seeking to rely on a deduction to reduce guideline income, the claimed service in fact needs to be performed, by someone competent to do so, and at a rate that is reasonable for the particular goods or services. This latter point applies to any category of expense. If, for example, a payor undoubtedly required a business office, but instead of leasing one at the average market rate of $5,000 month, opted for an obscenely luxurious office suite at $50,000 a month, complete with included spa service, open bar, and free use of the house Lamborghini, with no proof that the extra cost generated additional revenues, you can be sure that most of the expense would be disallowed and income imputed.
Contact us now at (604) 560-1400 and let the experienced and astute Self Employment Income Surrey Family Lawyers at Grandview Law Group LLP assist you in presenting your case and getting you the best possible result.