chairs

Steve Ranot, CA, CPA, CBV, IFA Marmer Penner Inc.

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

*CLE17-0060701-A-PUB*

Oren Weinberg Boulby Weinberg LLP

Sarah Boulby Boulby, Weinberg LLP

DISCLAIMER: This work appears as part of The Law Society of Upper Canada’s initiatives in Continuing Professional Development (CPD). It provides information and various opinions to help legal professionals maintain and enhance their competence. It does not, however, represent or embody any official position of, or statement by, the Society, except where specifically indicated; nor does it attempt to set forth definitive practice standards or to provide legal advice. Precedents and other material contained herein should be used prudently, as nothing in the work relieves readers of their responsibility to assess the material in light of their own professional experience. No warranty is made with regards to this work. The Society can accept no responsibility for any errors or omissions, and expressly disclaims any such responsibility.

© 2017 All Rights Reserved

This compilation of collective works is copyrighted by The Law Society of Upper Canada. The individual documents remain the property of the original authors or their assignees.

The Law Society of Upper Canada 130 Queen Street West, Toronto, ON M5H 2N6Phone: 416-947-3315 or 1-800-668-7380 Ext. 3315Fax: 416-947-3991 E-mail: cpd@lsuc.on.ca www.lsuc.on.ca

Library and Archives Canada Cataloguing in Publication

The Annotated Financial Statement for Family Law Lawyers

ISBN 978-1-77094-817-5 (Hardcopy)ISBN 978-1-77094-818-2 (PDF)

1

Chairs: Sarah Boulby

Boulby, Weinberg LLP

Steve Ranot, CPA, CA·IFA, CBV Marmer Penner Inc.

Oren Weinberg

Boulby, Weinberg LLP

June 19, 2017

9:00 a.m. – 12:30 p.m.

Total CPD Hours = 3 h Substantive + 30 m Professionalism

Law Society of Upper Canada 130 Queen St. West

Toronto, ON

SKU: CLE17-0060701

Agenda 9:00 a.m. – 9:10 a.m. Welcome and Opening Remarks

Oren Weinberg, Boulby, Weinberg LLP Steve Ranot, CPA, CA·IFA, CBV, Marmer Penner Inc.

THE ANNOTATED Financial Statement for Family Law Lawyers

2

9:10 a.m. – 9:50 a.m. Determining Income, Monies Received and Benefits and Expenses (10 minutes )

Oren Weinberg, Boulby, Weinberg LLP

Steve Ranot, CPA, CA·IFA, CBV, Marmer Penner Inc. 9:50 a.m. – 10:20 a.m. Assets (10 minutes )

Vivian Alterman, MBA, CPA, CA, CBV, ap Valuations Limited Lisa Kadoory, Kain & Ball Professional Corporation

10:20 a.m. – 10:30 a.m. Question and Answer 10:30a.m. – 10:45 a.m. Coffee and Networking Break 10:45 a.m. – 11:15 a.m. Liabilities

Georgina Carson, MacDonald & Partners LLP

Steve Ranot, CPA, CA·IFA, CBV, Marmer Penner Inc 11:15 a.m. – 11:45 a.m. Date of Marriage Assets and Liabilities and Excluded

Property Kim Kieller, Dooley Lucenti LLP Alla Levit, CA, CPA, CBV, IFA, Levit Valuations Inc.

3

11:45 a.m. – 12:20 p.m. Perspectives from the Bench and an Arbitrator

(10 minutes )

Moderators: Oren Weinberg, Boulby, Weinberg LLP Steve Ranot, CPA, CA·IFA, CBV, Marmer Penner Inc.

Panelists: Alfred Mamo, LSM, C.S., McKenzie Lake Lawyers LLP

The Honourable Justice Susanne Goodman, Superior Court of Justice

12:20 p.m. – 12:30 p.m. Question and Answer 12:30 p.m. Program Ends

1

Chairs: Sarah Boulby

Boulby, Weinberg LLP

Steve Ranot, CPA, CA·IFA, CBV Marmer Penner Inc.

Oren Weinberg

Boulby, Weinberg LLP

June 19, 2017

SKU: CLE17-0060701

Table of Contents TAB 1 Determining Income, Monies Received and Benefits and Expenses TAB 1A Income Determination: The Legal Issues ………………………… 1A – 1 to 1A – 13

Sarah Boulby, Boulby, Weinberg LLP

Presented by: Oren Weinberg, Boulby, Weinberg LLP

THE ANNOTATED Financial Statement for Family Law Lawyers

2

TAB 1B Income Determination for Matrimonial Purposes ………….. 1B – 1 to 1B – 28 Steve Ranot, CPA, CA·IFA, CBV, Marmer Penner Inc. TAB 2 Assets TAB 2A Some Considerations When Completing the Asset Section

(Part 4) of the Financial Statement ………………………………… 2A – 1 to 2A – 9

Vivian Alterman, MBA, CPA, CA, CBV, ap Valuations Limited TAB 2B Some Considerations when Completing the Asset Section (Part 4) of the Financial Statement ………………………………… 2B– 1 to 2B – 13

Lisa Kadoory, Kain & Ball Professional Corporation TAB 3 Income Tax and Other Debts and Liabilities in Family Law ……………………………………………………………………….. 3 – 1 to 3 – 6 Steve Ranot, CPA, CA·IFA, CBV, Marmer Penner Inc TAB 4 Date of Marriage Assets and Liabilities and Excluded Property TAB 4A Tracing in Family Law Equalization Circumstances ………………… 4A – 1 to 4A – 9

Kim Kieller, Dooley Lucenti LLP TAB 4B Date of Marriage Assets and Liabilities …………………………… 4B – 1 to 4B – 8

Alla Levit, CA, CPA, CBV, IFA, Levit Valuations Inc.

TAB 1A

Income Determination: The Legal Issues

Sarah BoulbyBoulby, Weinberg LLP

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

1

INCOME DETERMINATION: THE LEGAL ISSUES

Sarah Boulby

The Annotated Financial Statement for Family Lawyers

Law Society of Upper Canada June 2017

The most complex and interesting section of a form 13 or 13.1 Financial Statement is the

income section; that is, both intellectually interesting and potentially perilous to the family law

client. The purpose of the income section is to provide disclosure to the opposing party, and

the court, of the deponent’s income so that child and spousal support claims may be

accurately assessed. What creates the intellectual interest is the complexity of income

calculation under the family law statutes. Income is not the same for family law matters as for

tax matters. It is much broader in scope including monies received that may be non – taxable

or unearned, such as gifts. It may include monies that have not been received but are

potentially available to the deponent. The deponent spouse may, in all good faith, have no

ability to understand or explain his or her income for family law purposes. What creates the

potential peril is that forms 13 and 13.1 are affidavits. Given the opacity of family law income

analysis, a deponent spouse may quite easily err in how the income is reported. Once that

error is presented as sworn evidence in an affidavit the deponent is subject to cross-

examination and risks having his or her case founder on credibility problems. Given this

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context, counsel must approach preparation of financial statements with great care and

caution. This paper is a guidepost as to how to approach this task.

(a) What is income for family law purposes?

Since 1997, the Child Support Guidelines has framed what constitutes “income” in a

family law context. Although the Guidelines concern child support, courts apply the

analysis to the determination of income in spousal support cases.1

(b) How is income determined?

a. Sections 15-20 of the Child Support Guidelines structure the determination of

income. If spouses agree on income, the court may accept that amount for the

purposes of making a support order if the court finds the consent amount to be

reasonable in light of the evidence.2 Where the spouses do not agree, income is

determined applying s. 16-20 of the Guidelines.3

b. S. 16 of the Child Support Guidelines provides that: “…a spouse’s annual

income is determined using the sources of income set out under the heading

“Total income” in the T1 General form issued by the Canada Revenue Agency

and is adjusted in accordance with Schedule III.” That is, the deponent must

start with his or her line 150 income. This is then adjusted by the specific

1 Lavie v. Lavie 2015 CarswellOnt 14963 (S.C.) at para. 91 2 Federal Child Support Guidelines, SOR/97-175, as am., s. 15(2) 3 Federal Child Support Guidelines, s. 15(1)

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principles set out in Schedule III of the Child Support Guidelines. This section

must be read in conjunction with the Ontario Superior Court decision of Coghill

v. Coghill which provides that under s. 16 “one should consider the income

arising from the sources of income listed in every T1 General tax return….The

objective is to determine current income.”4

The income section of forms 13 and 13.1 asks for current income, not last year’s

income. By definition, line 150 income from the deponent’s tax return must refer

to, at best, the prior year’s return. The disclosure obligation is not to disclose the

prior year’s income but to disclose current income and the starting point is to

identify the current income for each category of income incorporated into the

prior year’s line 150. If, for example, the deponent had salary, interest and

dividend income in the prior year, then he or she should disclose the amount of

salary, interest and dividend available from these sources in the current year.

This works reasonably well for a deponent who earns a salaried income. If she

earned a $50,000 salary from her job last year as an employee of ABC Inc., as

disclosed on her return, but this year has received a raise and will earn $54,000

4 Coghill v. Coghill 2006 CarswellOnt 3890 (S.C.)at para. 27

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from ABC Inc., then $54,000 is the annual income to be reported. The difficulty

arises in cases in which the deponent has unpredictable income. A self –

employed person may genuinely have no idea until late in the year or after the

year is over what his or her income was for that year. In that case, the choice is

to use the prior year’s income, clearly indicated as such, or to estimate the

current year’s income. The basis for the income chosen must be clearly

identified on the statement by way of notes to the form.

c. Section 17 of the Child Support Guidelines provides that a court may look at a

spouse’s income over the last three years and determine an amount that is fair

and reasonable given any pattern of income, fluctuation in income or receipt of

non-recurring income and non-recurring losses during those years.

A deponent spouse may quite reasonably present an income analysis based on

s. 17 such as an average. Form 13 and 13.1 ask, however, for income the

deponent is currently receiving. It is acceptable to prepare the form using an

analysis under s. 17 as long as it is clearly identified as such and the deponent’s

actual income for the current year is disclosed, whether that be by reference to

an expert income report, notes to the form or attachments to the form.

d. S.18 of the Federal Child Support Guidelines provides for the inclusion of

corporate income into a spouse’s income for support purposes where the

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spouse is a shareholder, director, or officer of the corporation and the spouse’s

income otherwise does not fairly reflect the money available for the payment of

support, or where corporate income is paid to non-arm’s length parties. This

provision allows the piercing of the corporate veil to ensure that money held

inside a corporation is available for support. Where, however, there is a valid

business purpose to keep the monies in the company, income will not be

imputed to the recipient.5

Where a deponent controls a business, he or she should consider whether or

not to acknowledge that income should be imputed under s. 18 principles. For

example, a spouse with a professional corporation that accumulates retained

earnings year after year will be hard pressed to justify taking the position on the

13 or 13.1 financial statement that only income paid out as salary or dividend

should be included. Failing to address the issue openly will undermine that

deponent’s credibility in the proceeding.

e. S. 19 of the Federal Child Support Guidelines provides that a court may impute

income to a spouse in certain circumstances. These include where a spouse is

5 Wildman v. Wildman [2006] O.J. NO. 3966 (Ont.C.A.)

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intentionally under-employed or unemployed, the spouse is exempt from paying

tax or has unusually low rates of tax based on residency or the type of income,

the spouse has diverted income, has not used property reasonably to generate

income, has failed to make disclosure, unreasonably deducts expenses from

income, or is, or will be, in receipt of benefits from a trust. Section 19 is inclusive

and the courts have interpreted it to permit the imputation of gifts as income in

certain cases.6

Most of the categories listed under s. 19 have an element of impropriety to

them. A deponent is unlikely to complete a form 13 or 13.1 acknowledging that

income should be imputed for diverting income or failing to invest properly. If

counsel can see that there has been an evident shortcoming in how the

deponent has deducted expenses for tax purposes it might be sensible to

acknowledge that in preparing the financial statement with, of course,

appropriate advice from counsel to client as to the necessity of consulting an an

accountant about the issue and quite possibly re-filing personal or corporate tax

returns if the client has improperly claimed personal expenses as business

6 Bak v. Dobel (2007) CarswellOnt 2324 (Ont.C.A.).

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expenses. This may mean that the spouse has a related unpaid tax liability as of

the date of separation.

Section 19(2) of the Child Support Guidelines provides that even proper

expenses deducted for tax purposes may not be acceptable as deductions for

support purposes. There is a paucity of jurisprudence under this section. In an

early Guidelines decision, Cooke v. Colomy, the court held that the payor’s

business expenses were unreasonable under this section because he had a

pattern of losses suggesting that his business venture was more of a hobby

than a genuine attempt to garner profit.7 If so, the expenses would not meet the

standard for deduction for tax purposes either. Subsequent cases under this

section have followed this path, suggesting that the section does no more than

catch spouses who have successfully played audit roulette on their tax returns.8

The receipt of trust distributions or gifts, however, may well be income and as

such need to be included in the spouse’s form 13 or 13.1 disclosure. Trust

distributions may be taxable or non-taxable in the hands of the recipient. If non-

7 Cooke v. Colomy(1998)CarswellMan211 (Q.B.) 8 Aitken v. Aitken 2003 O.J. No. 2780 (S.C.) and Bhandari v. Bhandari 2002 O.J. No. 658 (S.C.) are cases under s. 19(2) in which losses from a passive stock portfolio held by, respectively, an accountant and a dentist inside their corporations were found not to be “business expenses at all.”

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taxable, then the recipient should consider calculating a gross up for tax

purposes. Section 19(1)(i) also considers imputing income to a support payor

who “will be” in receipt of income or other benefits of a trust, presumably

requiring clairvoyance.

Gifts may be included in income for support purposes after consideration of a

number of factors, including circumstances that mark them as exceptional, the

proportion of the income generated by the gifts in relation to the recipient’s

entire income, whether the gifts were paid to support an adult child through a

crisis, whether the gifts are likely to continue and their true nature. 9 If the gifts

cease, no income should be imputed.10 Gifts that are continuing, form a

significant part of the recipient’s monies received and are relied on by the family

during and after the marriage should be acknowledged on the financial

statement. Gifts that will not continue or are provided to assist a spouse in a

financial crisis or after separation to address temporary financial need (such as

for legal fees, to re-house, or to meet temporary support needs) should not be

included as income.

9 Bak v. Dobel, at para. 75 10 Korman v. Korman 2015 CarswellOnt 578 (Ont.C.A.)

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Income may be imputed based on a lifestyle analysis. In these cases the court

imputes income based on expenditures. The lifestyle cases are typically ones in

which a spouse lives beyond his or her means and the court believes that the

spouse has unreported income.11 The danger of imputing income based on

lifestyle is that a spouse who imprudently overspends is compelled to continue

to do so, the result being financial ruin. Where a deponent’s expenses greatly

exceed apparent income it is essential to explain how the gap is covered to

protect his or her credibility and avoid imputation based on lifestyle.

(c) Business and Employment expenses

Forms 13 and 13.1 provide for the disclosure of net business income, with the income

before expenses listed in the notes or in Schedule “A” to the form. It is helpful to attach

additional schedules to the financial statement to detail the expenses claimed. This

transparency makes it easier for both parties to assess the validity of the expenses

claimed. Once claimed as a deduction to the income, the deponent must avoid listing

the expenses as part of his or her budget.

11 Raphael v. Raphael 2003 CarswellOnt 47488

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Forms 13 and 13.1 do not provide for the reporting of employment expenses although

these are permitted as a deduction from employment income in certain circumstances

under Schedule III, s. 1 of the Child Support Guidelines. Although not required by the

form, it may make sense to disclose these in the notes or in an attached schedule so

that they are not over-looked.

(d) Ancillary income sources

Forms 13 and 13.1 require disclosure of a number of specific categories of income,

including:

a. Spousal support received from a former spouse/partner, but not support

received from a current spouse. Despite that omission, I think it helpful to

include spousal support from the current spouse as otherwise the income and

expenses parts of the form will not balance.

b. Social assistance income, including ODSP payments – This includes social

assistance income not attributable to the spouse, even though that is not

included for Child Support Guidelines purposes.

c. Child Tax benefits and HST rebates, and.

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d. RRSP withdrawals. As RRSP withdrawals are included in line 150 income, they

are prima facie income for support purposes and must be included as income

on forms 13 and 13.1.12 There is discretion under s. 17 to exclude these

withdrawals and that discretion will likely be exercised if the withdrawal

represents a consumption of capital. If, on the other hand, the RRSP is being

drawn down as part of a retirement plan, the funds will likely be treated as part

of income for support purposes.13

(e) Income Calculation Reports

The great innovation of the support guidelines is to take the focus of support

calculation away from spending, that is what the child or spouse needs to meet his

budget and onto earning, or what the payor has available to spend. The guidelines

were designed to work for salaried employees, for which they provide a simple

solution. All the complexity in the legislation and case law since has arisen in trying to

figure out how to normalize income from non-salaried sources. This has tremendously

broadened the financial disclosure required and the level of analysis needed to present

a spouse’s income accurately. In many cases, this necessitates an expert income

12 Fraser v. Fraser2013 CarswellOnt 15821 (C.A.) 13 McConnell v. McConnell 2015 CarswellOnt 4939 (S.C)

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calculation report. This is particularly necessary when tax adjustments or gross ups

need to be calculated or business practices assessed, such as what are the working

capital requirements of a business. Not every case, however, demands an income

calculation. To proceed with an income calculation in a straightforward case is an error

that needlessly increases the parties’ costs.14 If the court may discern the spouse’s

income based on the direct evidence without any need for specialized expertise, then

an income calculation is not required.

(f) The Role of Counsel

A form 13 or 13.1 is the client’s affidavit. It is the client who attests to the truth of its

contents. Having said that, particularly with respect to income it is the task of the family

lawyer in preparing the financial statement to rigorously review the financial

documentation, question the client, and, where appropriate, consult with the client’s

accountant and an independent valuator. Many, if not most spouses, lack the

understanding of the somewhat arcane rules of income determination in family law

necessary to properly fill out the financial statement. This lack of understanding may

be devastating to that spouse’s case if errors or omissions in the form 13 or 13.1 form

the basis of negative credibility findings. The increasing complexity of the

14 Howell v. Wignall 2015 ONSC 6910 (Ont.S.C.) at para 10-11

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jurisprudence has created a minefield for deponents. It is the family lawyer’s task to

guide the client through that minefield.

1A - 13

TAB 1B

Income Determination for Matrimonial Purposes

Steve Ranot, CPA, CA·IFA, CBV Marmer Penner Inc.

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

IInnccoommee DDeetteerrmmiinnaattiioonn FFoorr MMaattrriimmoonniiaall PPuurrppoosseess

By Steve Z. Ranot, CPA, CA•IFA, CBV MARMER PENNER INC.

Business Valuators & Litigation Accountants

Presented for The Annotated Financial Statement

For Family Lawyers On June 19, 2017

IInnccoommee DDeetteerrmmiinnaattiioonn FFoorr MMaattrriimmoonniiaall PPuurrppoosseess

By Steve Z. Ranot, CPA, CA•IFA, CBV MARMER PENNER INC.

Business Valuators & Litigation Accountants

INTRODUCTION

Be it for matrimonial purposes or income tax purposes, employees, investors

and business-people have sought to increase their net worth by minimizing the

appearance of their income. This paper examines a few of the methods

commonly used to minimize income and some of the ways to uncover these

techniques.

OPTIMAL UTILIZATION OF ASSETS

Before we delve into the word of forensic accounting and unreported income,

let’s deal with less nefarious ways to minimize income. We have all heard the

term Asset Allocation. Most often it is used in connection with risk

minimization in investment management. However, asset allocation or asset

mix can also affect income for support purposes.

Consider Ian the investor, who has a $1,000,000 portfolio. Prior to separation,

three quarters of the portfolio was invested in a mix of triple A corporate and

government bond yielding about 3% or $22,500 per annum. The remaining

$250,000 was invested in equities, some of which paid dividends. The average

dividend yield was 2%, so Ian earned $5,000 in dividend income for a total of

$27,500. In addition, Ian realized some capital appreciation on his equities,

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however, these were only realized when sold. After separation, Ian moved all of

his bond portfolio into lower dividend-paying equities so he now earned about a

1% yield on the entire $1,000,000. That reduces his annual income from

$22,500 to $10,000. It may seem apparent that Ian reallocated his assets in

order to reduce his support obligation. However, in an era of low interest rates

and high stock market returns, it is difficult arguing that Ian was acting in this

manner solely to defeat his spouse.

However, a different approach may have been promoted by the courts in the

Patterson decision, where the court deemed a husband’s employee stock options

to be cashed in and sold to realize a notional gain annually even when not

disposed of in actuality. Could the court do the same with unrealized capital

gains on a portfolio of marketable securities next?

Reallocating economic resources is not limited only to investments. For many

spouses, the greatest economic asset is themselves. Some spouses choose to

under-employ this economic asset in order to minimize support obligations. The

role of a business valuator and forensic accountant is called upon in these

circumstances to shed light where the income minimization is intentional. In

some cases, medical practitioners cite government cutbacks and clawbacks as a

reason for lower income. A comparison of revenues to prior years and

government limits is required. A further comparison to other similar

practitioners in the same geographic area is also warranted. Finally, a review of

the professional expenses may indicate that inflated expenses, not minimized

revenue are the actual culprit.

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Where partnerships are involved, the forensic accountant may wish to look more

carefully where the spouse’s income drops but the partner’s income rises. Once

again, it may be that the separated spouse has reallocated clients or profit

sharing in a temporary manner to reduce income. Where partners agree to act in

concert for mutual benefit, some of the transferred income may be repaid in cash

to the separated partner. A review of insurance record and patient appointment

books may indicate that a dentist, for example, continues to service his usual

patients while allowing a partner to report the income as his for accounting and

income tax purposes.

Does this mean that only the self-employed or investors can shift economic

assets to reduce their income? Not any more. A common and tax friendly form

of employee remuneration is the use of employee stock options. A stock option

is the right to purchase a security at a predetermined fixed price. Where the

value of the security has risen above the fixed price, exercising the option

provides a gain to the option holder. In a case from over ten years ago, a senior

bank executive magnanimously offered to his employer to reduce his salary

significantly in exchange for enhanced stock option benefits. If the company’s

stock price failed to rise, his gamble would not pay off. If the stock price rose

sufficiently, his gamble would leave him ahead of where his base salary would

have otherwise left him. To the shareholders, this created a sense of confidence

in the corporation’s future since the senior executive was betting a fortune on

the company’s growth. What was unknown to most was that the executive was

embroiled in a matrimonial dispute. The “salary for option” swap also provided

the bonus of temporarily reducing income for support purposes. The timing of

income from stock options is discretionary. In most cases, employee stock

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options are issued with a long exercise period, such as ten years. Accordingly,

an employee whose children are teenagers, will benefit from shifting current

income into stock option income which will likely be exercised after the

children are beyond the age at which support is still required. Once again, the

Patterson decision must be considered here as a mechanism to counter such a

strategy by the option-holder.

In all these examples, the first clue to income manipulation is sudden drop in

income after separation.

EXPENSE MANIPULATION

For the self-employed, income minimization can take other forms. One of the

simplest forms involves payments to non-arm’s length parties. It is not

uncommon to see management fees or salaries paid to family members or

friends in order to reduce business income. The forensic accountant should

review the cash disbursements and T4 summaries of a business and note the

names of recipients who may be non-arm’s length parties. These services

should be questioned and compared with previous years for reasonableness.

When reviewing the last three years’ income, don’t forget to look for payments

to a family trust or a corporation controlled by family trust for the benefit of

minor children. The 1999 federal budget tried to do away with this type of

income splitting. It should be noted that although the budget eliminated the

income tax advantages of income splitting with minor children through a family

trust, the business owner may still continue to make payments to a family trust

in order to reduce the business income. Under the post-1998 rules, any amounts

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paid to the minor children as dividends would be taxed at the high rate.

However, if the income is not paid out to the children, then the payment of

management fees to a trust or a company held by the trust would still achieve

reduced business income for the support payer. However, the two most recent

federal budgets have discussed measures that might eliminate the small business

tax rate to such a company. Stay tuned.

Next on the list of income reducing techniques is the practice of paying personal

expenses through a business by treating them as business expenses. The most

abused expenses tend to be entertainment, travel and automobile expenses. It

may help to speak with the non-titled spouse to find out which credit card was

used most often for personal entertainment and then review how these expenses

were recorded by the company – as either promotion expense or shareholder

advance. If charged to the shareholder account, then no impropriety exists and

no business expense was claimed.

One oft forgotten add-back is depreciation expense on real property. If the titled

spouse’s business earns either rental or business income from an owned

property, its depreciation expense on the building may be added back to income

for Guidelines purposes only.

OTHER INCOME ISSUES

If someone is forced to withdraw $10,000 from an investment account at a

brokerage firm, is that considered income? No, it generally considered a

reduction of capital. However, if that withdrawal is from an RRSP account, it is

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income for income tax purposes. In a nutshell, RRSP contributions do not

reduce Guidelines income but RRSP withdrawals technically increase

Guidelines income. Notwithstanding this apparent inequity, this is clearly how

the Guidelines read. Like many things in life (and in family law), it may not be

fair, but those may be the rules.

As indicated above, where rental income is earned, no allowance for

depreciation expense is allowed where computing income for Guidelines

purposes. It is important to remember that when indicating rental income on a

financial statement such as a Form 13, net rental income should be shown on the

front page. A mistake often seen is that rental revenue is indicated on the front

page and related rental expenses are included in the payer’s budget. Page 1 is

intended to show income. Accordingly, by indicating the related expenses in the

budget, income for support purposes may be overstated. The same issue arises

where investment income is shown on page 1 and investment expenses such as

related loan interest or professional fees are shown in the budget.

The Income Tax Act permits businesses to claim expenses with respect to an

office in a home if the office is used all or substantially for business purposes.

To calculate these expenses, in most cases a percentage of total housing

expenses are allocated to this one office. Accordingly, in a ten room house, if

one room is used as a business office, one tenth of all expenses such as mortgage

interest, utilities, property tax and insurance, etc. are claimed as business

expenses. While this is permissible for income tax purses, it may be

inappropriate for calculating income for support purposes as these business

expenses do not represent any incremental cost to the spouse in question. Had it

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not been for the existence of the business, these expenses would have been

incurred anyway, however, they would have been considered as personal

expenses.

TO CATCH A THIEF

All of these investors, professionals and business people who fool around with

timing issues or personal expenditures through their business, are small potatoes

compared to the underground business operator. We have all seen these cases.

A couple lives in an expensive home with little or no debt, one spouse claims a

lavish life style but the combined income on both spouses’ personal income tax

returns could not possibly justify a fraction of the cost of their alleged lifestyle.

Determining actual business revenues and expenses can be attempted in one of

two general ways. The front-end approach is to concentrate on the actual

business. In one case, we reviewed a hotel’s operations. The reported revenue

had seemed unreasonably low, however, the bank deposits tied in with the

registration book listing rooms rented. This hotel (like most we hope) laundered

its sheets and made beds everyday. By checking the laundry records we were

able to determine that the number of rooms cleaned exceeded the number of

rooms rented on a consistent basis. Since there was no reason to clean an

unused room, we showed that many of these apparent unused rooms were rented

for unreported cash payments.

A similar approach can be used in manufacturing businesses by studying the

inputs in, for example, an assembly process. If manufacturing a chair requires

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four legs and one seat, a review of the parts ordered compared to sales and the

change in inventory levels can help indicate unreported sales or understated

inventory.

These types of analyses are referred to as front-end approach because they

concentrate on the actual business itself. The bank end approach is used when

there are scant business records or the unreported income comes from a service

business where the cost of inputs is not correlated to the quantity of service

provided.

The back end approach (which is also used by Canada Revenue Agency when

assessing taxpayers with unreported income) is based on a knowledge that

opening net worth plus income minus living expenses equals ending net worth.

Determining current net worth is not difficult assuming there is no allegation

regarding hidden bank accounts. Opening net worth can be estimated based on a

net worth statement filled out a few years earlier for mortgage application. Even

those with unreported income tend not to understate their net worth on mortgage

applications knowing that higher net worth may shave half a point off their

interest rates. Annual costs of living must be estimated by records exist for most

major expenses such as mortgage payments, utilities, property taxes, children’

tuition, childcare and anything purchased on credit. The rest, such as groceries,

can be estimated by one spouse for the sake of accuracy. In a simple

assumption, Rudolf the renovator’s net worth was $200,000 four years ago. His

living expenses were calculated at $70,000 per year but his reported income is

$25,000 and his net worth has increased to $400,000. Based on these numbers,

Rudolf had to earn enough in four years to finance $280,000 (four times

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$70,000) of living expenses plus another $200,000 in net worth increase for a

total of $480,000. That’s $120,000 per annum. He reports $25,000 per year, so

his unreported income must be $95,000 per annum on average.

If these figures are supportable and Rudolf cannot show that any of this alleged

unreported income was actually gifts or loans from family, then one might be

content with basing support on $120,000 per annum. However, let’s not forget

that although Rudolf keeps $120,000 per year, he only pays tax on $25,000 so

he really earns the after-tax equivalent of someone earning closer to $200,000

per year. The Guidelines permit the court to adjust a payor’s income where the

tax rate paid by the payor is considered favourable. This is generally accepted

as intended to apply that someone earning significant dividends or capital gains

or someone living in another jurisdiction with lower tax rates. However,

consideration should be given to someone who has the ability to get away with

paying a significantly lower rate of tax than anticipated due to unreported

income.

Income Tax Gross-Ups

The Federal Child Support Guidelines (“the Guidelines”) allow a court to

impute additional income to a spouse who benefits from:

1) Being exempt from paying federal or provincial income tax (Section 19(1)

(b));

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2) Being taxed at lower effective rates by virtue of living in a country whose

tax rates are significantly lower than those in Canada (Section 19(1)(c));

3) Deducting excessive expenses from taxable income (Section 19(1)(g));

and

4) Deriving a significant portion of income from capital gains and Canadian-

source dividends, both of which are taxed at preferential rates (Section

19(1)(h)).

The additional amount added to the spouse’s income as a result of these income

tax advantages is known as an “income tax gross-up”. The applicability of a

gross-up is a legal issue but has become a commonly-accepted component of

Guidelines income where a spouse unreasonably deducts personal expenses.

The actual calculation of the income tax gross-up for the deduction of personal

expenses is not subject to much controversy. If a high rate taxpayer (assume a

marginal tax rate of 53%) deducts $10,000 of personal automobile expenses, we

add the $10,000 to income as well as an $11,277 gross-up using the logic that

one would need $21,277 additional pre-tax income to be left with this $10,000

after-tax benefit. We have seen the court accept these calculations many times.

However, let’s not be blind to the second highest type of tax paid, that is, the

HST. The spouse not only saved $11,277 of notional income tax but also

recovered the 13% HST (here in Ontario) by charging the automobile expenses

as business expenses. Had they been paid personally, the cost would have been

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$11,300 in after-tax money. So, shouldn’t the add-back really be $10,000 +

$1,300 + $12,743 to replicate the pre-tax equivalent to net $11,300 after-tax?

The income tax gross-up is also applied when a spouse benefits from lower

income tax rates on a significant portion of his/her income. “Significant” is

defined in the Merriam-Webster dictionary as “large enough to be noticed or

have an effect” but is not defined in the Guidelines. It has been our experience

that parties tend to agree that amounts less than 10% are considered less than

significant while amounts in excess of 25% are similarly agreed to meet the

“significant” threshold. It is the grey area between 10% and 25% that lacks

matrimonial judicial guidance.

The Income Tax Act defines “significant” in a number of areas as follows:

1) A corporation’s interest in a partnership is significant if it exceeds 10%

(Subsection 34.2(1));

2) A person’s interest in a corporation is significant if it amounts to 25% or

more of votes or entitlement to corporate value (Paragraph 80.01(2)(b));

3) For the purpose of the capital gains exemption, a reduction of dividends

by more than 10% of the average annual dividend is significant

(Subsection 110.6(8) 142.2(2)(b));

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4) For the purpose of financial institutions, a person’s interest in a

corporation is significant if it amounts to 10% or more of votes or

entitlement to corporate value (Paragraph 142.2(2)(b));

5) For the purpose of pooled pension plan, a person’s interest in a

corporation is significant if it amounts to 10% or more of votes or

entitlement to corporate value (Paragraph 147.5(30)(b)); and

6) For the purpose of certain tax-deferred vehicles, a person’s interest in a

trust is significant if it (together with related parties) amounts to 10% or

more of entitlement to value of all of the beneficiaries (Subsection

201.01(4).

Accordingly, if The Income Tax Act can be a source of guidance for the

Guidelines, then the threshold appears to be closer to 10% than 25%.

So, if a spouse deducts personal expenses from income or earns well over 10%

of his/her income from capital gains or Canadian-source dividends, an income

tax gross-up can be applied to increase income. What about 19(1)(c)’s

significantly lower tax rates in another country? Our top Ontario rate thanks to

Justin Trudeau and Kathleen Wynne has jumped from 46.41% to 53.53%. If the

10% rule applies, then perhaps any jurisdiction with a top rate below 48.17%

now meets the “significantly lower” threshold and the world has plenty more tax

havens than it used to.

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Back in the good old days, Canada was a lower-taxed jurisdiction than many

western European countries. Would the inverse apply to a payer-spouse residing

in the higher-taxed United Kingdom? In some cases, countries had lower taxes,

in part, because governments did not pay for certain services we in Canada take

for granted are paid by Big Brother. Accordingly, the cost of living might be

higher even if income taxes were lower. Both these questions were answered in

McGouran, where the UK support-payer could not reduce his income for the

higher cost of living in the UK.

We haven’t discussed Elizabeth Dowdeswell’s potential income tax gross-up.

Does nobody remember that she is Ontario’s 29th lieutenant-governor and the

Queen’s representative at Queen’s Park? Canada cannot tax the Queen’s

representatives so that includes David Johnston, as well. Uh, he’s our governor-

general in Ottawa. I actually thought you would have recognized that name. If

any of these representatives have their income determined under the Guidelines,

it will include a “significant” gross-up.

Income Tax Deductible Expenses

Thank god for subsection 19(2) of the Guidelines! For those who have drawn a

blank, subsection 19(2) states that for the purpose of determining a spouse’s

Guidelines income, the reasonableness of a particular expense for Guidelines

income determination is not solely governed by its deductibility under the Act.

This appears to imply that deductibility under the Act is a starting point and

weighs in the expense’s favour. There are a couple of common instances where

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deductibility under the Act should not reflect a similar treatment for Guidelines

income.

The Act permits certain employees to deduct expenses related to a workspace in

the home [subsection 8(13) of the Act] and also permits an individual reporting

business income to do the same [subsection 18(12) of the Act].

In order to be deductible as either an employment expense or a business

expense, the workspace in the home must be either:

(a) The individual’s principal place of business; or

(b) Used exclusively for the purpose of earning income and used on a regular

and continuous basis to meet clients, customers or patients.

Where an individual has an office provided to him elsewhere by an employer or

has a principal place of business elsewhere, it may be difficult to meet either of

the two tests above to qualify for deductibility of the workspace in the home.

Where an individual, named Penelope, has inappropriately deducted expenses

relating to a home office for income tax purposes, it is appropriate to add the

home office expenses in determining Penelope’s Guidelines income. It may also

be appropriate to calculate an income tax gross-up for the additional income tax

savings for which Penelope was not entitled.

What if the individual is entitled to deduct home office expenses for income tax

purposes? Should his/her Guidelines income include this deduction? Consider

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two individuals – Tom and Jerry. Both Tom and Jerry operate businesses which

earn $100,000 per annum. Both live in identical houses with identical mortgage

interest, property tax, utilities, insurance and maintenance expenses totalling

$24,000 annually. Tom regularly meets with clients in one room in his home

while Jerry does so only at his work premises. Tom does not incur any

additional home expenses as a result of these home meetings. If Tom’s home

office occupies one-sixth of his home, he may deduct $4,000 (1/6 of $24,000)

annually from his business income. As a result, Tom pays less income tax than

Jerry and may report lower income for the Guidelines, too - all this despite not

incurring any incremental expenses.

This leaves the two questions:

(a) Should the home office expenses properly deducted by Tom for income

tax purposes be added to his Guidelines income because there was no

actual incremental cost to him? and

(b) Should any add-back, if appropriate, be subject to an income tax gross-

up?

This is likely a legal issue best left to the courts to decide. However, it may not

be appropriate to add the income tax gross-up as it would equate Tom’s position

with that of Penelope who obtained an income tax advantage unfairly while Tom

has not contravened any tax rules.

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We look forward to guidance from the courts as home office expenses are a

common deduction among those earning business income and is also claimed as

a deduction on occasion by those earning employment income.

Another dubious Guidelines expense might be interest as evidenced by the

Singleton case. John Singleton was a partner in a law firm. He wished to

borrow $300,000 to buy a house. However, he wished to make the interest on

his loan deductible. Interest on loan to purchase a personal residence is

generally non-deductible.

Singleton withdrew $300,000 from the capital account of his law firm and used

the money to purchase a home. He then went to the bank and borrowed

$300,000 and used that money to repay his capital account at the law firm.

Singleton reasoned that tying the loan to the partnership capital would make the

interest deductible.

CRA denied Singleton’s claims of interest expense. Singleton appealed to the

Tax Court of Canada which sided with CRA. Singleton then appealed to the

Federal Court of Appeal which set aside the lower court’s ruling that the interest

was non-deductible. CRA took the case to the Supreme Court which sided with

Singleton.

The Tax Court of Canada originally found the money was not borrowed for

business purposes because the purpose of the loan was to buy a home. They

said that all the transactions Singleton undertook were related and therefore they

should be considered as one transaction. The Federal Court of Appeal disagreed

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and found the interest was deductible because the direct use of the funds was to

refinance his capital account in the partnership.

As a result of the Supreme Court decision, the tax courts are bound to accept this

type of tax planning as legitimate tax planning. However, family law

practitioners are not bound by this. Just as other discretionary business expenses

may be added to a payer’s income pursuant to the Guidelines, so could Mr.

Singleton’s interest expense.

INCOME OVER WHICH THE SPOUSE HAS ACCESS AND CONTROL

We normally apply the principles of access and control in determining income

for spousal support purposes. It is unclear whether these same principles are to

be applied under the Guidelines for child support purposes.

Access means that the corporate income is available for distribution to the

spouse. To the extent that any portion of the corporate income must be retained

in the company for capital reinvestment or due to restrictions imposed by the

bank, the spouse may not have access to this income. In determining whether

the spouse has access to the corporate income, we consider capital reinvestment

requirements, banking covenants, shareholder agreements, historic practices of

the corporation and the financial status of the corporation.

Capital reinvestment requirements of the corporation are crucial. The

Guidelines refer to a case where the spouse earns income through a partnership

and state that any amount included in his income that is properly required by the

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partnership for purposes of capitalization should be deducted. However, the

Guidelines are silent with respect to the capitalization requirements of a

corporation.

Take the case of a business which earned $1,000,000 of pre-tax income in the

most recent year. The pre-tax income included a deduction for depreciation on

the existing capital assets of $100,000. The business is capital intensive and

$400,000 must be reinvested to maintain this level of pre-tax income. The

required capital reinvestment of $400,000 exceeds book depreciation of

$100,000 by $300,000. Therefore, the spouse has access to only $700,000

($1,000,000 - $300,000) of the pre-tax income of the business. Where

depreciation properly reflects the annual capital reinvestment, no adjustment

should be made.

Banking covenants also play an important role. The current banking agreements

should be carefully examined to determine what debt to equity ratios, current

ratios or any other ratios must be met. As well, the banking agreement may

specify the maximum amount of shareholder remuneration. Previous corporate

practice in terms of meeting the banking requirements should be tested.

Consider the case where the banking agreement limits the shareholder

remuneration to $100,000 per annum, unless specific approval is obtained from

the bank. The corporation earns a pre-tax profit of $900,000 after payment of a

salary of $100,000 to the spouse. The spouse claims that the income over which

he has access and control is $100,000. He claims he does not have access to the

$900,000 retained in the company due to bank restrictions.

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Further investigation reveals that the banking agreement is five years old. The

company’s financial position has improved dramatically in the last year. The

spouse has not requested specific approval from the bank to withdraw more than

$100,000. If an additional $900,000 was distributed from the company, it would

still be in a healthy financial position. As well, you find that the company

purchased a $500,000 home in which the spouse resides rent-free. All of the

above factors indicate that the spouse may in fact have access to the corporate

income despite the bank restrictions.

The financial health of the company is also important in determining the

corporate income to which a shareholder has access. Consider the case of a

company which has a substantial deficit. Much of its pre-tax income may need

to be retained in the company to reduce the deficit and bring its debt to equity

ratios and current ratios to an acceptable level. The debt to equity ratio

measures how heavily the company is leveraged. The current ratio measures

whether the assets which will be converted to cash in the current year are

sufficient to meet the liabilities which will become due in the current year.

The accounting methods employed by the company should also be examined. A

company with long-term contracts may recognize its revenue on a percentage of

completion basis, before payment is received, if payment is reasonably assured.

A start-up company in this scenario may appear financially healthy on its books,

however, it may be cash strapped. This would limit the distribution of profits in

the near future.

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Control means that the spouse can dictate how much of the income may be

distributed and when it is distributed. In determining whether the spouse has

control over the timing and the quantum of the income distributed from the

corporation, we consider the percentage of ownership held by the spouse, and

the distribution of the remaining shareholders. As well, the relationship of the

shareholders in the company is important. At one end of the spectrum is the

shareholder who owns 100% of the company and exercises complete control

over the distribution of the corporate earnings. At the other end is the minority

shareholder of a public company whose only income derived from the company

is the dividends received.

A 30% shareholding, where the balance of the shares is held by immediate

family members may not mean lack of control. We usually assume that a family

acts in concert unless specific facts exist that prove otherwise. It is also possible

that a minority shareholder’s position in the company or special knowledge and

expertise, or relationship with key clients, provide him/her with additional

control beyond the stated shareholding.

RETAINED EARNINGS VS. INCOME

Retained earnings represent an accumulation of undistributed profits from the

inception of the company to date. They do not represent undistributed profits

for the most current year. This erroneous interpretation may lead to inequitable

results.

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In an Alberta case, the judge included the retained earnings of the company in

determining the husband’s Guidelines income. He relied on another Alberta

case, where the court concluded that the retained earnings of the husband’s

business should be taken into account in establishing his Guidelines income on

the basis that it represents a real asset that the husband could have taken as

income if he had chosen to do so.

We consider both decisions to be inequitable. In establishing “true income”, one

should not include retained earnings, which represent an accumulation of

undistributed income of all prior years.

Consider a company which pays a $50,000 salary to its shareholders each year

and retains $200,000 of pre-tax income or $156,000 after-tax income per annum.

If the company has been in operation for five years, its retained earnings should

be $780,000 ($156,000/year for five years). Based on the decisions above, the

spouse’s income would be $830,000 ($50,000 salary plus $780,000 retained

earnings). However, the annual pre-tax income of the spouse is in fact his salary

of $50,000 and the pre-tax corporate income of $200,000 or $250,000.

Although the retained earnings of $780,000 can all be distributed in one year,

the ongoing earnings capacity of the spouse is $250,000. The fact that the

shareholder chose not to distribute all of the earnings of the company and

accumulated substantial retained earnings should increase the fair market value

of the company and should be equalized through property division.

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BUSINESS EXPENSES WITH A PERSONAL COMPONENT

Under the Guidelines, the court may impute income where the spouse

unreasonably deducts expenses from income.

Often business expenses have a personal component to them. These include, but

are not limited to:

a) home office expenses;

b) auto expenses;

c) travel expenses;

d) meals and entertainment;

e) promotion;

f) club dues;

g) legal and accounting fees; and

h) personal renovations.

The reasonableness of an expense deduction is not solely governed by whether

the deduction is permitted under the Income Tax Act.

As well, under the Guidelines, salaries, wages, management fees or other

payments or benefits to non-arm’s length individuals would be added to the pre-

tax income of the corporation, unless the spouse establishes that the payments

were reasonable in the circumstances. Therefore, salaries to spouses or children

for income splitting purposes where no services were provided would be added

to the pre-tax income of the corporation.

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With respect to deductions of capital cost allowance on real estate, the

Guidelines indicate that where a spouse makes such deductions this would be

added back in calculating the spouse’s income. The Guidelines are silent as to

whether depreciation on real estate deducted by the corporation should be added

back.

HIDDEN BENEFITS

In addition to the ability to deduct expenses which have a personal component to

them, the shareholder may be deriving hidden benefits which are not reflected in

the company financial statements. These may include:

a) Interest free loans;

b) Personal use of company automobile; and

c) Personal use of real estate owned by the company without payment of

rent.

PROJECTED VS. HISTORIC INCOME

Consider the case of a company with a July 31 year-end. The company had the

following pre-tax profits in its three most recent years:

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July 31, 2016 2015 2014 Pre-tax income before shareholder remuneration $600,000 $300,000 $300,000 Less: Salary to shareholder (100,000) (100,000) (100,000) Bonus to shareholder (300,000) -- -- Pre-tax corporate income $200,000 $200,000 $200,000

The $300,000 bonus to shareholder in the year ended July 31, 2016 does not

have to be paid for six months or until January 31, 2017. Therefore, the

shareholder will only be reporting the bonus in his 2017 personal income tax

return. His personal income tax returns from 2014 to 2016 would show the

following:

Projected 2017

Actual 2016

Actual 2015

Actual 2014

Employment earnings $400,000 $100,000 $100,000 $100,000

The Guidelines indicate that the court may determine the spouse’s annual

income to include all or part of the pre-tax income of the corporation.

Therefore, the Guidelines envisioned inclusion of the $200,000 of pre-tax

corporate income which would bring the spouse’s income for Guidelines

purposes to $300,000 ($100,000 + $200,000) for 2014 to 2016. The additional

bonus of $300,000 earned in 2016, but not paid until 2017 would properly bring

the taxpayer’s income up to $600,000 in 2017. This was confirmed in the

Korkola decision in 2009 (with a twist).

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WORK IN PROGRESS

Work in Progress, or “WIP” as it is referred to in accounting terminology, is the

time docketed, which has not been billed.

Until the 2017 federal budget, the Income Tax Act allowed certain professionals

to elect not to include WIP in income. These professionals are accountants,

lawyers, medical doctors, veterinarians and chiropractors. Other professionals,

such as architects, engineers or management consultants, for example, must

include WIP in income for tax purposes. Many professionals in the former

category choose the income tax method, and do not account for WIP in their

financial statements. The Guidelines rely on taxable income and are silent on

the issue of whether any adjustment should be made for WIP.

This particular issue was decided in Augaitis v. Augaitis. The husband was a

lawyer. He argued WIP should not be included in income for the following

reasons:

1. Under the Income Tax Act, lawyers are allowed to exclude WIP in

calculating their income; and

2. Inclusion of WIP produces an unrealistically high income, which does not

reflect actual cash on hand, out of which support must be paid.

The wife argued that inclusion of WIP is the method favoured by the accounting

profession, since this method provides for proper matching of revenues and

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expenses. In other words, it reflects most accurately the balance between the

revenues and the expenses for that year.

The judge decided the appropriate method for calculating income for support

purposes, is the income tax method, for the following reasons:

1. The exclusion of WIP causes an income deferral only. The unbilled WIP

of one year will likely be included in billings of the following year. For

the purposes of long-term support, the average level of income from year

to year will not be altered no matter which method is chosen; and

2. The Guidelines have chosen the income tax method for calculating

income. Courts should be wary of deviating from those Guidelines,

unless there is strong reason to do so.

The judge’s ruling was complicated by the particulars of the husband’s situation.

The husband had no WIP at the beginning of the year. This is because his

former partnership was dissolved, and one of the terms of the dissolution was

that each partner had to bill out all WIP at the end of the prior year. The

husband’s billings for the year were $76,330. His WIP at the end of the year

was $38,670, or approximately 50% of his billings. Using normal accounting

practices, the WIP would be included, increasing his income to $115,000

($76,330 + $38,670). Using the income tax method, his income would be

$76,330.

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Since the judge ruled the income tax method was appropriate and the husband

did not have to include WIP in calculating income, the income of $76,330 would

have been calculated. However, the judge noted that this rule by itself would

produce an unrealistically low figure. This was because there was no WIP at the

beginning of the year to bill out during the current year, as it had all been billed

out at the end of the prior year. The husband received a payout of $27,000 from

his former firm in winding-up. To rectify the situation, the judge included the

figure of $27,000 in lieu of prior year’s WIP that would normally have been

billed out during the current year, increasing the husband’s income to $103,330

($76,330 + $27,000).

In effect, the judge included WIP. However, instead of including the WIP at the

end of the current year, the judge included an amount in lieu of the WIP at the

end of the prior year in calculating current year’s income.

This decision indicates that, where there are no extenuating circumstances, for

professionals who are allowed to exclude WIP for income tax purposes, the

same method should be used in arriving at income for child support purposes.

However, where the billings are not representative of the normal income, due to

unusual circumstances, the court may make adjustments. Given that this was a

lower court decision in the Barrie Family Court, it remains to be seen whether

higher courts will uphold this decision.

In the case of professionals who must include WIP in income for income tax

purposes, WIP should be included in calculating income for child support

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purposes. Given that all professionals must soon do so as a result of the 2017

federal budget, this will likely become a well-accepted concept.

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TAB 2A

Some Considerations When Completing the Asset Section

(Part 4) of the Financial Statement

Vivian Alterman, MBA, CPA, CA, CBV ap Valuations Limited

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

   

1    

The   Annotated   Financial   Statement   for   Family   Law   Lawyers:     Some  

Considerations   when   Completing   the   Asset   Section   (Part   4)   of   the  

Financial  Statement  

 

Vivian  Alterman,  ap  Valuations  Limited    

 

As  business  valuators,  we  assist  clients  and  counsel  in  determining  the  value  of  certain  assets  to  

be  reported  in  Part  4  of  the  Form  13.1  Financial  Statement.    These  assets   include  but  are  not  

limited  to:  

• Business  interests.  

• Loans  receivable.  

• A  book  of  business.    

• Stock  related  employee  benefits.  

• Bonus  receivable.  

• Trust  interests.  

• The  value  of  a  legal  claim.  

In  this  paper,   I  will  briefly  discuss  these  assets  and  other  considerations  when  completing  the  

asset  section  of  the  Financial  Statement.    

 

Business  Interests  

Business   interests   may   include   corporations   or   unincorporated   businesses   such   as   sole  

proprietorships,   partnership   interests,   joint   ventures   and   co-­‐tenancies,   among   others.     A  

valuation  report  prepared  by  an  independent  valuator  may  be  required.        Some  businesses  are  

simple   in  operations  and   therefore  do  not   require  a   formal  valuation   report.     For  example,  a  

business  may  be  just  a  “job”  for  the  business-­‐owning  spouse  and  its  value  may  be  represented  

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2    

by   the  book  value  of   its  net  assets.     In   these  cases,  a   formal  valuation  report  prepared  by  an  

independent   valuator   may   not   be   required   and   an   estimate   of   the   value   of   the   business  

determined  by  management  and/or  their  external  accountant  can  be  included  in  the  Form  13.1.  

If   it   is   determined   that   a   formal   valuation   report   is   required,   then   an   independent   valuator  

should   be   retained   to   prepare   the   valuation   given   issues   of   objectivity,   independence   and  

materiality  of  the  assets.    

 

As   Chartered   Business   Valuators   (CBVs),   we   are   governed   by   the   practice   standards   of   the  

Canadian   Institute   of   Chartered   Business   Valuators   (www.cicbv.com).     The   CICBV   provides  

practice  standards  with  regards  to  the  preparation  of  valuation  reports.    A  valuation  report   is  

defined  as  a  report  that  contains  a  conclusion  as  to  the  value  of  shares,  assets  or  an  interest  in  a  

business.     There   are   three   types   of   valuation   reports:   i)   Calculation,   ii)   Estimate,   iii)  

Comprehensive.     The   calculation   report   provides   the   lowest   level   of   scope,   corroboration,  

assurance   and   disclosure,   while   a   comprehensive   report   provides   the   highest.     The   type   of  

valuation   report   that   is  appropriate  will  be  dependent  on   the  nature  of   the  engagement  and  

client  budget  considerations.    When  reviewing  a  report  the  key  is  not  to  focus  on  the  name  of  

the   report   or   its   label   (Calculation   or   Estimate)   but   rather   the   scope   of   work,   documents  

reviewed  and  assumptions  made  in  the  report.    The   limitations  of  a  report  will  be  outlined   in  

these  sections.    The  Rules  of  Civil  Procedure  require  that  an  expert  provide  evidence  that  is  fair,  

objective   and   non-­‐partisan.     These   rules   are   consistent   with   the   requirement   of   the   CICBV  

practice  standards  of  fairness  and  objectivity.    In  this  regard,  expert  reports  will  include  a  signed  

Form   20.1   Acknowledgment   of   Expert’s   Duty   that   outlines   an   expert’s   duty,   including   an  

acknowledgement  that  the  expert’s  duties  to  the  court  override  any  client  obligations.      

 

Disclosure    

The   preparation   of   a   valuation   requires   a   significant   amount   of   disclosure   including   but   not  

limited  to:  

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3    

• Documents  to  verify  ownership  (corporate  minute  books);  

• Financial  statements  and  underlying  documents  (general  ledgers,  trial  balances);  

• Tax  returns  (other  tax  balance  information);  

• Details  of  non-­‐arm’s  length  payment  (market  salaries,  rent);  

• Details  of  transactions  related  to  shares/assets  near  valuation  date;  and,  

• Offers  to  buy  business.  

The  list  above  is  not  exhaustive  and  depending  on  the  complexities  of  the  business  to  be  valued  

there  may   be   additional   requests  made   based   on   information   received   and   reviewed   as   the  

valuator   continues   with   their   work.     Counsel   needs   to   educate   their   client   about   disclosure  

requirements.     Clients   need   to   understand   that   a   valuation   cannot   be   prepared   without  

disclosure  and  that  disclosure  requests  may  be  ongoing  (i.e.,  a  preliminary  list  will  be  sent  and  

then  others  will   likely  follow).    Disclosure  is  critical  when  dealing  with  the  financial   issues  in  a  

family  law  matter.    The  appropriate  disclosure  in  any  case  will  depend  on  the  facts  specific  to  

the  case,   including  but  not   limited  to,   the  types  and  quantum  of  nets  assets.    For  example,  a  

spouse  that  owns  a  small   landscaping  business  whose  clients  are  small   residential  clients  and  

there  are  allegations  of  unreported  cash  revenues  will  have  different  disclosure  requirements  

than   a   spouse   that   has   a   landscaping   business   whose   clients   are   large   commercial   clients.    

Sometimes  valuators  spend  more  time  in  requesting  and  managing  information  requests  than  

time  spent  on  the  valuation  exercise.    Appropriate  disclosure  does  not  mean  that  valuators  are  

entitled   to  any  and  all   information.    However,   valuators   cannot   complete   their  work  without  

relevant   financial   disclosure,   and   for   counsel   disclosure   is   a   key   component   of   managing   a  

family  law  matter  that  should  be  given  due  consideration  up  front.    

 

Loans  Receivable    

Loans   owing   to   a   spouse   need   to   be   considered   as   assets   for   property   division   and   valued.  

Some  valuation  reports  will  outline  the  loans  owing  to  a  business  owner  from  the  business  that  

need  to  be  considered  as  a  personal  asset  on  Form  13.1.    If  not,  one  needs  to  consider  whether  

the  business  has  a  liability  to  the  spouse  that  has  been  considered  in  the  valuation  and  should  

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be  captured  as  a  personal  asset   for   family   law  purposes.    The  fair  market  value  of  a   loan  will  

depend  on  whether   the   loan   is   considered   collectible,   the  amount  of   interest  being   charged,  

and  the  timing  of  receipt  of  both  the  principal  and  interest  payments.      

 

Book  of  Business  

Generally,  a  stock  broker  or   investment  advisor  (IA)  will  have  a  book  of  business  or  accounts.      

The  value  of  a  spouse’s  book  of  business  is  an  asset  that  needs  to  be  included  in  Form  13.1.    The  

position  that  a  book  of  business  is  not  an  asset  of  the  IA  but  rather  an  asset  of  their  firm  is  not  

supportable.      

The  book  of  business  will  provide  the  IA  a  stream  of  revenue  in  the  form  of  commissions  or  fees  

for  financial  management  services.    The  clients  that  comprise  the  book  of  business  are  generally  

loyal  to  the  investment  advisor.    Some  brokerage  firms  have  formal  purchase  plans  for  the  book  

of  accounts  to  assist  in  transitioning  the  book  of  business  from  one  IA  to  another  in  cases  where  

an   IA   is   retiring  or   leaving   the   firm.    The  value  of   the  book  of  business  may  be  based  on   the  

metrics  in  the  formal  purchase  plans  of  the  firm,  the  metrics  implied  by  transactions  of  similar  

books  within  the  firm  and/or  rules  of  thumb.    The  value  of  the  book  of  business  may  have  to  be  

discounted  for  the  number  of  years  until  retirement.    

 

Stock  Related  Employee  Benefits  

 Stock   related   employee   benefits   (SREB)   include   employee   stock   options,   stock   appreciation  

rights   (SARS),   restricted   share  units   (RSU),  performance   share  units   (PSU)  and  deferred   share  

units   (DSU),   among   others.     SREBs   are   typically   granted   to   senior   employees   of   public  

companies,   such  as  banks.     They   can  also  be  granted  by  private   companies   such  as   software  

start-­‐ups.    SREBs  are  assets  that  need  to  be  included  and  valued  for  property  division  purposes.  

SREBs  tend  to  have  the  following  key  features:  i)  they  are  tied  to  the  future  performance  of  the  

company  (i.e.  future  stock  price);  and,  ii)  they  vest  over  time  to  encourage  employee  retention.    

SREBs   usually   cannot   be   sold,   transferred   or   leveraged   by   the   employee.     As   such,   value   is  

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determined  on  a  “value  to  owner”  basis.    Value  to  owner  is  typically  defined  as  the  amount  an  

individual  would  pay  so  as  not  to  be  deprived  of  an  asset.    Typically,  the  value  of  a  SREB  is  based  

on  the  stock  price  as  at  the  valuation  date  subject  to  a  discount  for  any  restrictions  and  vesting  

period.    Each  SREB  plan  is  different  due  to  considerations  for  the  plan’s  unique  restrictions  and  

triggering  events   (i.e.,   vesting   time).       In   the   case  of   stock  options,   the   valuation   is   generally  

based  on  an  option  pricing  model  subject  to  further  discounts  that  consider  vesting  periods  and  

other  restrictions.    

 

Due   to   the  complexities  associated  with   these  assets,  CBVs  are  generally   retained   to  prepare  

valuation   reports.     At   a   minimum,   our   disclosure   requirements   will   include   employment  

contracts,  stock  incentive  plan  and  schedules  outlining  SREBs  outstanding  at  the  valuation  date.  

In  some  cases,  a  valuation  is  not  practical  due  to  uncertainties  (such  as  establishing  the  share  

price   of   a   private   software   company   without   revenue   and   a   product   at   early   stages   of  

development),   or   the   benefit   is   large   and   results   in   an   equalization   payment   that   cannot   be  

funded  until   the  benefit   is   realized.     In  these  cases,  an  “if  and  when”  approach  to  settlement  

can  be  used  if  agreed  to  by  the  parties  (i.e.  when  the  asset  is  realized  it  is  shared  between  the  

parties  on  an  after-­‐tax  basis).    

 

Bonus  Receivable  

A  bonus  that  is  receivable  at  the  valuation  date  or  after  the  valuation  date  needs  to  be  included  

as  property  for  division.    The  amount  of  the  bonus  receivable  to  be  included  may  be  based  on  a  

pro-­‐rated  amount  to  consider  the  amount  earned  at  the  valuation  date.    If  the  bonus  is  for  past  

performance  (i.e.  before  the  valuation  date)  then  the  full  amount  of  the  receivable  should  be  

included  as  property  for  division,  on  an  after-­‐tax  basis.    If  the  amount  of  the  bonus  is  not  known  

at  the  valuation  date  then  the  bonus  may  be  considered  a  contingent  asset  for  property  division  

purposes.     In  this  case,  the  fair  market  value  will  depend  on  the  term  of  the  bonus,   including  

whether   the   bonus   amount   is   dependent   on   future   performance   features,   and   the   ability   to  

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predict  the  outcome  based  on  information  available  at  the  valuation  date  (i.e.,  historically  have  

performance  targets  been  met).  

Trust  Interests  

A  contingent  interest  in  a  discretionary  or  non-­‐discretionary  trust  is  property  for  division.    Trust  

interest   cannot   be   sold,   transferred   or   leveraged   by   the   beneficiary.     In   this   regard,   value   is  

determined  based  on  “value  to  owner”.  The  value  to  owner  represents  the  lump  sum  amount  

that  the  beneficiary  spouse  would  be  willing  to  accept  rather  than  waiting  to  receive  the  trust  

funds.      

The  value  of  a  non-­‐discretionary  trust  depends  on  the  underlying  assets  of  the  trust,  the  timing  

of  expected  distributions,  whether  the  beneficiary  has  an  income  or  capital  interest  in  the  trust,  

among  other  considerations.    

The  value  of  a  discretionary  trust   is  difficult  to  determine  because  the  discretionary  nature  of  

the  asset  provides  much  uncertainty.    

The   starting   point   is   to   value   the   trust   as   a  whole.     Of   this  whole,   the   amount   that  may   be  

attributable   to   the   discretionary   beneficiary   spouse   needs   to   be   determined.     Such   a  

determination  is  a  legal  issue.  

Due   to   the  complexities  associated  with   these  assets,  CBVs  are  generally   retained   to  prepare  

valuation   reports.     At   a   minimum,   disclosure   requirements   will   include   trust   settlement  

agreements/deeds,   trust   income   tax   returns   including   T3   slips   showing   distributions   to  

beneficiaries,  and  trust  financial  statements  among  others.    

In   some   cases,   if   the   benefit   is   large   and   results   in   an   equalization   payment   that   cannot   be  

funded  until  the  benefit  is  realized,  as  an  alternative  to  a  lump  sum  payment,  an  “if  and  when”  

approach  to  settlement  can  be  used  if  agreed  by  the  parties.    

 

 

 

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Legal  Claim  

A   legal   claim   or   lawsuit   is   a   contingent   asset   for   property   division   purposes.     The   value  will  

depend  on:  

• The  amount  of  the  claim;  and,  

• The  likelihood  or  probability  of  success.  

Due   to   the   complexities   associated   with   these   assets,   CBVs   may   be   retained   to   prepare  

valuation  reports  including  various  scenarios  related  to  the  likelihood  or  probability  of  success.    

At   a   minimum,   disclosure   requirements   will   include   pleadings,   status   of   matter   (including  

settlement   discussions)   and   direction   from   counsel   on   the   lawsuit   with   regards   to   the  

probability  factors  to  apply  based  on  the  strength  of  the  case,  among  others.    

In   some   cases,   if   the   benefit   is   large   and   results   in   an   equalization   payment   that   cannot   be  

funded  until  the  benefit  is  realized,  as  an  alternative  to  a  lump  sum  payment,  an  “if  and  when”  

approach  to  settlement  can  be  used  if  agreed  by  the  parties.    

 

Other  Factors  to  Consider  

Some  other  factors  to  consider  in  completing  the  asset  section  of  the  Form  13.1:  

• A  spousal  RRSP  is  owned  by  the  recipient  spouse,  not  the  spouse  that  contributes  to  the  

plan  even  though  the  contributor  receives  the  deduction  for  tax  purposes.  

 

• The  value  of  publicly   traded  shares  held  by  a  spouse   is  often  determined  as  the  share  

price  per  the  stock  exchange  at  the  valuation  date  times  the  number  of  shares,  however  

there  are  situations  where  the  value  could  be  higher  or  lower.    For  example,  a  blockage  

discount  may  be  warranted  when  the  block  of  stock  to  be  valued  is  so  large  (relative  to  

the  volume  of  actual  sales  on  the  existing  market)   that   the  block  could  not  be  quickly  

liquidated  without  depressing  the  market  price.  

 

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• Income  tax  receivables  or  refunds  that  arise  due  to  RRSP  contributions  or   installments  

need  to  be  considered  property  for  division.    A  spouse’s  income  tax  returns  before  and  

after  the  valuation  date  and  notice  of  assessments  should  be  reviewed.  

 • A  retirement  compensation  arrangement  (RCA)  is  a  plan  or  an  arrangement  under  which  

an  employer  makes  contributions  to  a  person,  referred  to  as  a  custodian.  The  custodian  

holds  the  funds  in  trust  with  the  intent  of  eventually  distributing  them  to  the  employee  

upon   retirement.     RCAs   are   similar   to   RRSPs,   however   they   are   generally   set   up   by  

privately  held  companies  for  their  owners/employees  and  can  often  be  assets  missed  in  

preparing  a  spouse’s  Form  13.1.  

 • Registered  Education  Savings  Plans  are  generally  not  included  as  a  property  for  division  

as   the   parties   generally   agree   that   the   funds   will   be   used   to   fund   the   children’s  

education.    However,  it  is  important  to  consider  that  if  the  funds  will  not  be  used  by  the  

children  to  fund  post-­‐secondary  education  costs  then  the  subscriber  can  withdraw  the  

funds  for  their  personal  use.      

 • Bonus  points/air  miles  can  be  valued  based  on  their  redemption  value  as  established  by  

the  providers  or  carved  out  and  divided  in-­‐kind.  

 • Employee   termination  payments   refer   to  a   reward   for  past   service,  not   for   lost   future  

income.     Termination   payments  may   be   property   for   division   if   it   can   be   established  

that,  the  spouse  had  a  clear  right  to  payment  at  the  valuation  date  and,  the  right  to  the  

benefit  was  earning  during   the  marriage.     The  value  of   the   termination  payment  may  

have   to   be  multiplied   by   a   probability   factor   to   reflect   the   uncertainty   related   to   the  

triggering  event  for  the  payment.      

 

Concluding  Remarks  

Valuators  work  with  counsel  and   their   clients   to  assist   in   completing   the  asset   section  of   the  

Form  13.1   in  many  degrees.     In  some  cases,   the  valuator  may  prepare  a  valuation  report.     In  

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other   cases,   the   valuator   may   also   help   identify   often   missed   assets.     The   amount   of   the  

valuator’s   involvement   will   depend   on   the   nature   of   the   case.     This   paper   has   provided   an  

overview  of   some  of   the   factors   to   consider   in   completing   the   asset   section   of   the   Financial  

Statement  from  a  valuators  perspective.    

 

 

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TAB 2B

Some Considerations When Completing the Asset Section

(Part 4) of the Financial Statement

Lisa Kadoory

Kain & Ball Professional Corporation

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

1

The Annotated Financial Statement for Family Law Lawyers: Some

Considerations when Completing the Asset Section (Part 4) of the

Financial Statement

Lisa Kadoory, Kain & Ball Professional Corporation

What is Property and How is it Reported for Family Law Purposes

Definition of Property

Integral to the equalization scheme in Ontario, is the obligation of spouses to account for all

their assets as of the date of marriage and separation.

If a court proceeding has been commenced, it is mandatory to account for these assets on the

Financial Statement prescribed by the Family Law Rules. Even if a matter is not in litigation, it is

wise to complete this Financial Statement as doing so helps to ensure that comprehensive

financial disclosure has been made.

When completing Part 4 of the Form 13.1 Financial Statement, one should consider what

constitutes property for equalization purposes. Section 4(1) of the Family Law Act defines

property as follows:

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“property” means any interest, present or future, vested or contingent, in real or

personal property and includes,

(a) property over which a spouse has, alone or in conjunction with another person, a

power of appointment exercisable in favour of himself or herself,

(b) property disposed of by a spouse but over which the spouse has, alone or in

conjunction with another person, a power to revoke the disposition or a power to

consume or dispose of the property, and

(c) in the case of a spouse’s rights under a pension plan, the imputed value, for family

law purposes, of the spouse’s interest in the plan, as determined in accordance with

section 10.1, for the period beginning with the date of the marriage and ending on the

valuation date.

In light of this broad definition, the assets reported at Part 4 of the Form 13.1 Financial

Statement might include items like:

• Beneficial ownership of realty or other property;

• A life interest in real property;

• Monies owed to a party (perhaps even if the debtor has defaulted on the loan) or a

shareholder’s loan (perhaps even if there is no guarantee that it will be paid back in the

future);

• The value of a legal claim;

• Stock related employee benefits;

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• A bonus receivable;

• Employee termination benefits;

• A book of business;

• Trust interests.

While the definition of property set out in the Family Law Act, is broad, as put forward by the

Ontario Court of Appeal in Lowe v. Lowe1, this definition:

…is not without limits. In Pallister v. Pallister, [supra], Misener J. acknowledged the

apparently "all-encompassing nature of the definition of 'property'", but pointed out

that as "property in law is simply a right or a collection of rights" identified by "no single

criterion, or even a discrete number of criteria", interpretation is required to contain the

category of property within limits appropriate to achieve the purpose and object of the

legislation as a whole…

Reporting Assets

It is important to consider the following when reporting assets on a Form 13.1 Financial

Statement:

1 2006 CanLII 804 (ON CA) at para. 12

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• Relevant Timeframe:

The relevant timeframe for determining assets that are subject to equalization starts at

the date of marriage and ends at the valuation date (which is synonymous with the date

of separation). Assets acquired prior to the date of marriage are not subject to

equalization (except a matrimonial home that does not change throughout the

marriage) and the same holds true for assets acquired subsequent to the valuation date.

Assets accrue during the relevant timeframe either because (a) property that existed as

of the date of marriage increases in value or (b) new assets are acquired.

• Extent of Ownership Interest:

A party must report the portion of an asset’s value that corresponds to the extent of

his/her ownership interest.

As previously noted, it is not only legal ownership that is relevant for the purposes of

calculating one’s net family property value. This goes to say that if a party holds all or

part of an asset for someone else’s benefit, this should be appropriately reflected on

his/her Financial Statement. Similarly, if someone else holds all or part of an asset for

the benefit of a party, this must be reported on his/her Financial Statement.

• Determining Value:

In many instances determining the value of an asset can be as simple as recording the

figure appearing on the statement for the asset that correlates with the valuation date

(or the date of marriage for that matter). Other assets (IE realty, stock options, a party’s

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business interests) are more difficult to value and call for an expert’s input. That said,

there is no requirement in the Family Law Act or the Family Law Rules that a party must

obtain appraisals or valuations of assets. As noted by the Honourable Justice Aston in

Kaptyn Estate(Re)2:

I agree with the statement of D.J. Gordon J. in Michi v. Michi, 2008 CarswellOnt

118 (Ont. S.C.J.) that it is unacceptable to record "unknown" in the required

financial statement. It is also well known since the oft-cited case of Menage v.

Hedges (1987), 8 R.F.L. (3d) 225 (Ont. U.F.C.) that the onus of establishing the

value of property is on the party owning same. However, the only requirement in

the Rules is that the Respondents be able to provide a sworn financial statement

with figures they are prepared to defend as bona fide estimates of their belief.

The figures must be based on an adequate factual foundation, after having made

a reasonable investigation.

Often Ignored or Misunderstood Assets

Foreign Assets

Ontario courts do not have the jurisdiction to make orders against foreign immovable

property3. This principle is often conflated with the obligation to include assets located outside

of Ontario in the calculation of net family property, such that foreign assets are left out of the

equation.

2 2008 CanLII 55140 (ON SC) at para. 11 3 Jung v. Jung, 2016 ONSC 3020 (CanLII) at para. 18

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As previously mentioned, pursuant to the Family Law Act, property is broadly defined as “any

interest, present or future, vested or contingent, in real or personal property.” This definition

easily captures assets outside of Ontario.

Equalization does not call for assets themselves to be divided between spouses – only their

value. Accordingly, there is no jurisdictional obstacle insofar as including foreign assets in the

calculation of one’s net family property.

Missing Values in Relation to Pensions

As a result of the legislative changes that took effect January 1, 2012, pension plan

administrators, as opposed to actuaries, value provincially registered pension plans pursuant to

a prescribed formula to come up with a “Family Law Value.” Consequently, various contingent

assets that are not included in the pension plan administrator’s determination of value and that

would have previously been caught in the reports prepared by independent actuaries may be

overlooked. Some examples of these contingent assets include:

• Additional voluntary contributions;

• Excess member contributions

• Supplementary Executive Retirement Plans;

• Non-guaranteed indexing; and

• Sick Benefit Retirement Gratuities.

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Lawyers must be vigilant not only in terms of examining the assumptions that shape the Family

Law Value put forward by the pension plan administrator but also in identifying whether there

are other sources of value to be considered. Seeking out the assistance of an actuary may be

prudent.

The Matrimonial Home

The matrimonial home is an asset that clients are frequently confused about. Most understand

that it is special and treated differently from other assets but have a distorted sense of why,

believing that:

• Regardless of how title is held, they have an ownership interest in the matrimonial

home and are automatically entitled to half the value of the property;

• There can only be one matrimonial home;

• The term matrimonial home and principal residence are interchangeable;

• The date of marriage value of a matrimonial home can never be deducted;

• They can force the sale of the matrimonial home simply because it is a matrimonial

home.

These misconceptions are, in some cases, perpetuated when half the value of the matrimonial

home is included on the non-titled spouse’s financial statement absent any explanation as to

why.

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In turn, the non-titled spouse assumes that he/she is entitled to the post-separation increase in

value of the matrimonial home without putting forward the basis to establish an equitable

ownership interest in the property.

When considering these issues, it is important to remember that:

(a) To establish an interest in the matrimonial home by way of resulting trust, a financial

contribution to the acquisition of the property by the non-titled spouse is required4; and

(b) The Ontario Court of Appeal’s decision in Martin v. Sansome5 has made it difficult for a

married spouse to succeed with a constructive trust claim because “In the vast majority

of cases any unjust enrichment that arises as a result of the marriage will be fully

addressed through the operation of the equalization provisions of the Family Law Act.”

Dealing with Challenging Clients

When it comes to financial disclosure there are commonly two types of challenging clients.

First, there are those who, in concert with their spouses, decide that financial disclosure is not

necessary and will not be exchanged. This type of client wants a quick resolution and explains

that the exchange of financial disclosure is a waste of time and money as he/she knows what

4 Tadayon v. Mohtashami, 2015 ONCA 777 (CanLII) at para. 47 52014 ONCA 14 (CanLII) at para. 64

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his/her spouse has in terms of assets (or does not care to know); trusts his/her spouse and/or

has already arrived at an agreement with respect to the parties’ assets.

This type of client simply wants you, the lawyer, to formalize the settlement terms the parties

arrived at through direct discussions.

Some strategies for dealing with this type of client are:

• Canvassing with the client why he/she retained a lawyer and thought it important to

enter into a formal agreement. Usually, the client will explain that he/she wants finality,

to tie up all loose ends and to conclude his/her financial affairs in a manner that will

stand the test of time. When the client understands that a lack of financial disclosure

can seriously undermine these objectives, this can make him/her more amenable to

preparing a Financial Statement and insisting that his/her spouse do the same;

• Explaining to the client that any decision about how to settle financial issues - even the

decision to forgo certain entitlements - should be an informed one, based on full

financial disclosure;

• Forecasting some potential scenarios with the client to help him/her understand what

they may be giving up and how they really feel about it (IE What if you found out Tom’s

pension was worth $800,000; How would you feel if you discovered that Rachel had

valuable stock options as of the date of separation; What would your reaction be if

Andrew bought a very expensive home a year after you signed the separation

agreement).

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The second type of challenging client simply refuses to provide financial disclosure.

Sometimes, the client who refuses to disclose has, throughout the marriage, been left in the

dark regarding finances and owns minimal property. In turn, he/she becomes acutely focused

on uncovering his/her spouse’s property and resentful that the spouse with “nothing” must

produce “everything” while the spouse with “everything” produces “nothing.”

It is helpful to explain to this type of client that although, in the larger scheme of things, his/her

financial disclosure will have a modest impact on the numbers, failing to provide it serves as an

excellent distraction from the issues in the case that are truly important.

This type of client must be made to understand that, as frustrating as it may feel, being on the

right side of the obligation to provide comprehensive financial disclosure is never a mistake.

In other cases, it is the client with complex assets and significant net worth who refuses to

disclose.

This type of client must be made to understand that courts consider the non-disclosure of

financial information to be “the cancer of matrimonial property litigation”6, that early missteps

pertaining to disclosure can taint the way he/she is perceived by the court throughout the

entire proceeding and that serious consequences can arise as a result of the continued failure

to meet one’s disclosure obligations (IE cost sanctions, a finding of contempt, adverse

inferences being drawn, the striking of pleadings).

6 Decaen v. Decaen, 2012 ONSC 966 (CanLII) at para. 175

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It may be that by the time a client retains you his/her disclosure is already severely lacking.

Turning this around is a priority and may involve retaining an expert who can:

• Assist with the compilation of relevant disclosure;

• Value complicated assets before the client’s spouse even asks for this to be done;

• Be the first to prepare income and business valuation reports so that the client is not on

the defensive, responding to reports prepared by his/her spouse’s expert; and

• Lend credibility to the client’s numbers given the expert’s independence, experience

and qualifications.

Common Errors and Risk Management

Perhaps one of the most common errors is failing to regularly update a client’s Financial

Statement notwithstanding that doing so is mandated by Rule 13(12) of the Family Law Rules

and that one should go beyond the requirements of this rule if it is known that the information

reported on his/her Financial Statement is no longer true.

The failure to correct a statement that one knows has become untrue may be construed as a

fraudulent misrepresentation and warrant the setting aside of an agreement or court order that

was induced by the false information.7

7 Virc v. Blair, 2016 ONSC 49 (CanLII)

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Educating clients about the consequences of outdated, inaccurate financial disclosure and

making it common practice to connect with them at regular intervals to specifically address

whether the information set out in their financial statements remains accurate can help to

avoid this pitfall.

Other common errors that occur in the course of preparing a Financial Statement may include:

• Failing to inquire as to where the funds in a bank or investment account that a client

holds jointly with his/her spouse came from. If the funds deposited in the joint account

were gifted to or inherited by your client during the marriage, then, unlike a

matrimonial home, his/her share of the joint account can be excluded8;

• Including, as an asset on a client’s Financial Statement, money owed to him/her, even

though recovery is time-barred;

• Excluding an asset at Part 7 of the Form 13.1 Financial Statement without first including

it at Part 4;

• Including on a client’s Financial Statement a debt that it time barred;

• Failing to capture less common assets on the Financial Statement (IE a lawsuit,

timeshare, life interest in real property or country club membership).

8 Townshend v. Townshend, 2012 ONCA 868 (CanLII) at paras. 30 to 33

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Many of these errors arise from a lack of communication/understanding between the client and

his/her lawyer. Creating a standard set of questions to be put to clients which are geared

toward obtaining/flushing out this kind of information may be of assistance.

On a broader level, failing to get the appropriate financial expert involved at the right time (or

at all) is a mistake that is commonly made when preparing Financial Statements. Clients may

resist working with experts because of the cost involved but it is important to highlight for them

that failing to do so may increase legal fees, unnecessarily force a matter to trial, lengthen a

potential trial and/or lead to determinations based on deficient evidence, thereby giving the

client far less value for the dollars he/she has spent.

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TAB 3

Income Tax and Other Debts and Liabilities in Family Law

Steve Ranot, CPA, CA·IFA, CBV Marmer Penner Inc

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

IInnccoommee TTaaxx aanndd OOtthheerr DDeebbttss aanndd LLiiaabbiilliittiieess iinn

FFaammiillyy LLaaww

By Steve Z. Ranot, CPA, CA•IFA, CBV MARMER PENNER INC.

Business Valuators & Litigation Accountants

Presented for The Annotated Financial Statement

For Family Lawyers On June 19, 2017

INCOME TAX AND OTHER DEBTS AND LIABILITIES IN FAMILY LAW

Presented at the Annotated Financial Statements for Family Lawyers

By Steve Z. Ranot, CA• CA•IFA, CBV

Marmer Penner Inc. Business Valuators and Litigation Accountants

While debts and liabilities are generally viewed in a negative light, they take on a positive spin when a matrimonial dispute arises. No longer are debts something to be avoided. Instead, the spouses search high and low for evidence of all possible debts at the valuation date to lower net family property. Debts and liabilities comprise any amount owed by the title spouse to any person. A person includes individuals, corporations and trusts, both arm’s length and non-arm’s length. In general, all debts and liabilities can be broken down into two categories – tax and non-tax. The non-tax liabilities tend to be easier to quantify as most are loans. Quantification of these liabilities may be as simple as relying upon a statement dated at or near the valuation date. One possible adjustment to a loan relates to the spread between the interest rate on the loan and the market rate at the valuation date for debt of comparable risk. Consider a spouse who borrows $500,000 on a mortgage when the long-term rate was 10%. At the valuation date, the market rate had dropped to 5%. If this spouse still had three years left to pay interest at 10%, that debt may be worth more than $500,000 due to the onerous rate of interest attached to it. Similarly, when interest rates rise, existing debt with relatively low interest rates may have a value less than the face value of the mortgage. The formula for the present value of a loan is:

FV PV of loan = ———— + an┐r

(1 + r)n where PV = present value FV = face value of loan r = market interest rate per annum n = number of years until debt is repaid a = annual interest charged on the loan

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For a ten year interest-free loan for $100,000 from a family member and a current market rate of 5%, the value of this loan may be calculated as:

$100,000 PV of loan = ——————

(1 + 5%)10

= $61,391 Loans from non-arm’s length parties may be at low or no interest rates. Where these are demand loans, that is, with immediate payment required on demand, no adjustment is required. Where the loan is long-term, downward adjustments may be appropriate. Where a spouse is self-employed, that is, he/she owns a corporation, there may be recorded on the books of the corporation assets representing advances to the spouse. What is a corporate asset is also a personal liability to the spouse. This situation may also create an income tax liability. A shareholder advance that is outstanding for two consecutive fiscal year ends typically must be included in the shareholder’s income until repaid. Real property and investments have non-tax selling costs associated with them, primarily being broker and legal fees. These will be incurred regardless of any gain or loss on sale for income tax purposes. The tax liabilities on a financial statement can once again be broken down into two categories – those due immediately, and those expected to be incurred at a later date. The court’s view on the latter has changed over the years. In the past, the court only considered tax debts that were immediately due or were required to be incurred in order to liquidate assets to fund an equalization payment. Ever since the Sengmueller decision, the accepted practice has been that all expected future liabilities should be adjusted by an appropriate present value factor. In the current low interest rate environment, there may be no need to apply present value adjustments to debts payable within a year of the valuation date. Where the liability has been crystallized and is interest bearing, as is all debt to Canada Revenue Agency (“CRA”), there is no need to present-value the amount. These current tax debts include arrears tax on prior tax returns already assessed or reassessed. In most cases, a recent notice of assessment or reassessment should provide the appropriate debt amount. However, where the taxpayer has or intends to appeal the

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assessment or reassessment, the right value is somewhere between the taxpayer’s position and CRA’s position. Where determination of an expected outcome is impossible to make, it may be appropriate to leave the liability as “to be determined” and set aside an amount in escrow sufficient to fund the liability if and when it becomes exigible. To the extent the taxpayer’s position is correct, any amount remaining in escrow should be split between the spouses after the dispute with CRA has been settled. Where a separation occurs on any day other than December 31st, there will likely be a tax liability relating to the year of separation that cannot be quantified by that year’s tax return alone. Adjustments will be required for income and deductions realized after the valuation date. For example, the spouses separate on November 30th and that year’s tax return shows the spouse receiving a $10,000 tax refund. One cannot assume that this $10,000 or even 11/12 of it, was due to the taxpayer on the valuation date. In fact, if it turns out that the taxpayer made a $30,000 contribution to a Registered Retirement Savings Plan (“RRSP”) on February 28th after separation, there was actually close to a $4,000 tax liability owing on the date of separation. All of the refund resulted from the post V-day RRSP contribution. The Income Tax Act allows for certain income to be deferred until it is received. If a taxpayer sells a property in 2005 and takes back a five-year mortgage for the proceeds of disposition, the gain on sale may be deferred such that only 20% is recognized each year for the five years after the sale. Accordingly, if the title spouse separates in 2008, there still remains a tax liability for years after the property sale. A review of the personal income tax returns of the spouses will uncover these types of liabilities. When determining date of marriage income tax liabilities for unincorporated businesses, the calculation may be more complex for dates prior to 1995. Consider a spouse with a January 31 year end and a March 31, 1994 date of marriage. At that date, the taxpayer had not yet filed a 1993 personal income tax return which reports professional income up to January 31, 1993. In addition, the self-employed spouse has already earned income for the fiscal year ended January 31, 1994 with no tax having been paid on this amount either. Finally, a two-month stub period from February 1, 1994 to March 31, 1994 has already passed and accordingly additional income tax not expected to be paid until April 30, 1996 has to be calculated. In some family law matters, the issue of unreported income may arise. For the spouse who has earned this unreported income, it may be prudent to make a voluntary disclosure to CRA. After all, any tax liability will reduce net family property so this is a one-time opportunity to eliminate the risk of penalties on reassessment and pay the tax and interest at fifty cents on the dollar. As the debt existed at the valuation date and is subject to interest, no present value adjustment is required. The client should be advised that non-disclosure of unreported income leaves a taxpayer exposed to penalties which may be as high as 100% of

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the tax evaded plus compound interest on both the tax and the interest. As a result, the liability can easily exceed the unreported income itself. Once the current tax liability is dealt with, we turn our minds to what the future holds. Similar to the capital gains reserve discussed above is the 1995 Stub Period Reserve. Prior to 1995, unincorporated businesses could select non-calendar year-ends. This changed in 1995 and taxpayers were given a ten-year period to spread out their tax liability for the stub period created between the previous non-calendar year-end and December 31, 1995. The last portion of this liability was to have been paid by April 30, 2005. Up until then, each year’s tax liability created by the reserve must be considered with a present value factor applied to each specific year. An RRSP holds pre-tax assets. No tax is payable on these amounts until they are withdrawn. RRSPs must be either liquidated or converted at the end of the year the taxpayer turns 71. After the expected future tax on the RRSP is calculated, a present value factor based on the average age of withdrawal is applied. For a 50-year old spouse with a life expectancy of age 81, the average age of withdrawal is 76, or the mid-point between 71 and 81. For employer or Registered Pension Plans (“RPPs”) and Deferred Profit-Sharing Plans (“DPSPs”) the approach is similar. However, the pension likely starts before age 71, so the mid-point is based on an earlier starting point, usually age 60 or 65. A Registered Retirement Income Fund (“RRIF”) is similar to an RRSP except that the required withdrawals have already commenced. Most RRIF-holders are already 71 or older so the present value factor is less significant. Capital property includes portfolio investments and real property held as an investment. Any gain on the sale of these is treated as a capital gain and subject to tax at varying rates based on the valuation date. Prior to 1972, capital gains were not taxable. Between 1972 and 1987, only 50% of a capital gain was required to be included in taxable income. For 1988 and 1989, the inclusion rate rose to 66.67% and as high as 75% for 1990 to 2000. In 2000, the inclusion rate dropped twice, first to 66.67% and then back to 50% so there are three different rates that applied to dispositions in that year. When depreciable property is sold, some of the gain may be treated differently as the amount received up to the original purchase price represents “recaptured” depreciation. This portion of the gain is taxed as regular income and not subject to a reduced tax rate. Many people are under the mistaken belief that “there is no tax on a principal residence”. This is only true when there is one principal residence. Where spouses own more than one

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property such as a home and a cottage, both qualify as a principal residence, however, the ability to designate a property for the principal residence exemption is limited to one per year. Accordingly, the spouses may choose to allocate their principal residence designation in any manner they so choose which they believe will minimize their income tax liability. Where property is held by a taxpayer as inventory, such as raw land held for redevelopment, the gain on disposition is taxed as regular income and not as a capital gain. Accordingly, all of the income is taxable. For many unincorporated businesses, such as dentistry practices, the value of the business includes a component for transferable goodwill. In many cases, on eventual sale of the practice, only the sale of goodwill will generate taxable income. The sale of goodwill, while not technically a capital gain, is taxed at similar rates. When a taxpayer chooses to liquidate an interest in an incorporated business, the taxpayer may choose to either sell the shares of the corporation or cause the corporation to sell its assets and then pay out the proceeds to the shareholder. A sale of shares is generally simpler and has certain advantages, such as the availability of the capital gains exemption in certain circumstances. On the other hand, some businesses, such as investment holding corporations, rarely can find a willing buyer for their shares. Accordingly, the sale of assets followed by wind-up of the corporation is the most common form of disposition by a taxpayer. Each of these methods of disposition is taxed at different rates and has complicating factors. For the sale of shares, there are complex rules to determine whether the sale qualifies for the capital gains exemption. On a wind-up of a corporation, the proceeds of disposition to the shareholder are taxed as a dividend. However, the quantum of the taxable dividend is affected by the calculation of the corporation’s capital dividend account and refundable dividend taxes on hand. For shares of Qualified Small Business Corporations (“QSBC”) and Qualified Farm Property (“QFP”) the Lifetime Capital Gains Exemption limit was $500,000 for about twenty years until, recently, it increased to above $800,000. Both QSBC’s and QFP’s are subject to strict definitions which must be met. In some cases, corporations which are not QSBC’s can be “purified” so as to meet the definition. Similarly, the use of farm property can be adjusted to meet the definition of QFP. Both of these sets of rules must be understood by your valuators to properly quantify the tax costs of disposition on these types of property. The last two decades have seen the growth in popularity of certain types of tax shelters which provide investors with immediate tax deductions. These include oil and gas flow-through investments, real estate limited partnerships and film limited partnerships. In all these cases, the taxpayer’s adjusted cost base is reduced by the tax deductions in the early years. As a result, on eventual wind-up of the partnership, there will be some combination

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of taxable capital gain and other income. As some of these partnerships have pre-determined lives of up to 15 years, it is important to review this area in detail with the spouse to determine whether any latent and long-forgotten tax liabilities exist. While this paper has discussed all sorts of Canadian income taxes, it should not be forgotten that many spouses are residents or citizens of other jurisdictions. All US citizens must pay estate taxes on death. Furthermore, any individual residing in Canada receiving foreign source income such as US or UK pension income must first pay tax on this income stream in the originating country. For example, a spouse may have a Florida condominium which qualifies as a principal residence for Canadian tax purposes. However, there is no such concept as a principal residence for US income tax purposes. Accordingly, while no Canadian income tax is exigible on a sale of a property, US income tax will apply to any gain on sale. This paper has attempted to highlight many of the major debts and liabilities that may appear on a financial statement. However, it is not intended to be a conclusive listing. For as long as people remain creative, new types of debts and liabilities will continue to appear. The role of the family law professional is to leave no stone unturned in the search for every possible debt and liability.

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TAB 4A

Tracing in Family Law Equalization Circumstances

Kim Kieller Dooley Lucenti LLP

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

THE ANNOTATED FINANCIAL STATEMENT FOR FAMILY LAWYERS

Date of Marriage Assets and Liabilities and Excluded Property

By:

Kim S. Kieller, Dooley Lucenti LLP

INDEX

1. Fact Situation

2. Tracing In Family Law Equalization Circumstances: K Kieller and Ainsley Hunter, Dooley Lucenti LLP

Final Fact Scenario

1 Henry and Julie were married in May 1995. They have two children Barry (17) and Portia (15).

2 The parties separated in November 2016.

3 Henry’s grandfather Mervyn was a mining prospector. He came upon a gold find north of Yellowknife in the mid-1960s. The gold mine was profitable and Grandfather Mervyn was bought out by a mining consortium from Brazil and Toronto. From the sale proceeds, in 1990, the husband’s grandfather, Mervyn, created a trust. The beneficiaries of the income from the trust were Mervyn’s sons (one of whom was Niles who was the husband’s father). The capital was to be paid out to the settlor’s grandchildren (the husband’s generation) after the last of Grandfather Mervyn’s children died. The husband’s father Niles died in January 2017. He was the last child of his generation. (contingent assets on the date of marriage and increase on value of the contingent asset on valuation date)

4 Julie inherited $350,000 in 2010 from her paternal grandmother. From the funds she invested the sum of $100,000 into a RSP. The value of the RSP at separation was $180,000. She also put $100,000 of the funds into a joint investment with Henry for the children’s future education (although the investment is not a RESP or an “in trust account”. No funds have been withdrawn from the investment, but will be drawn in the next year when Barry commences his post-secondary education program. The fund value is currently $200,000. (tracing and increase in value of exclusions from receipt until valuation date)

5 In addition, Julie spent the sum of $50,000 to renovate the previous matrimonial home owned solely by Julie (Hamlet Road) for creditor reasons. By that renovation, the home increased significantly in value and the parties were able to then purchase their current residence. Due to both the market and the renovation, the parties sold the previous Hamlet Road matrimonial home for double what they originally paid for it. The offer to originally purchase the Hamlet Road home was accepted one month before the marriage but the closing of the purchase did not occur until two weeks after the marriage when Henry and Julie retuned from their honeymoon. Both the deposit and down payment for the Hamlet Rd. home were gifts from Julie’s parents. The deposit was provided at the time of the acceptance of the Offer and the down payment was provided on closing. (Matrimonial home or not for exclusion and tracing, contingent asset on date of marriage deduction/exclusion)

6 Julie used the rest of the inherited money for the family needs as time went on.

7 On the marriage, Henry had a series of investments with a Trust Company that no longer exists as it was purchased in 2000 by the AD Bank. The records were not properly transferred from the Trust company to AD and are lost. Henry can locate his tax returns showing interest income but cannot locate the actual bank book. (Proving deductions)

8 Julie had a student line of credit of $10,000 on the date of marriage. Her parents paid the loan for her birthday gift six months after the marriage. (Debt on marriage/gift during marriage)

9 Henry’s mother died in 2000. She left an inheritance for Henry. Henry, in his own name, purchased a rental duplex with the funds (and a mortgage). Henry earns about $1,500 per month from

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this investment. Henry’s mother’s will included the standard FLA terms for income earned from the inherited money. (Use of income from and for excluded property)

10 Both parties have significant RSP investments purchase with earned income.

11 Henry’s sister Ophelia, was in financial distress a few years ago. Henry loaned her $20,000. No payments have been made by Ophelia on the loan (but she keeps promising to pay Henry back from the Trust funds from Henry’s grandfather.).(Deduction of liability on valuation date)

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1

Tracing

Excluded Property Under the Family law Act

According to section 4 of the Family Law Act:

4(2) The value of the following property that a spouse owns on the valuation date does not form part of the spouse's net family property:

1. Property, other than a matrimonial home, that was acquired by gift or inheritance from a third person after the date of marriage.

2. Income from property referred to in paragraph 1,if the donor or testator has expressly stated that it is to be excluded from the spouse's net family property.

3. Damages or a right to damages for personal injuries, nervous shock, mental distress or loss of guidance, care and companionship, or the part of a settlement that represents those damages.

4. Proceeds or a right to proceeds of a policy of life insurance, as defined under the Insurance Act, that are payable on the death of the life insured. 5. Property, other than a matrimonial home, into which property referred to

in paragraphs 1to 4 can be traced. 6. Property that the spouses have agreed by a domestic contract is not to be included in the

spouse's net family property. 7. Unadjusted pensionable earnings under the Canada Pension Plan.

(3) The onus of proving a deduction under the definition of "net family property" or an exclusion under subsection (2) is on the person claiming it.

Tracing in Family Law

The principles of tracing excluded property to determine the value of the exclusion was imported from the law of trusts. The use of tracing in family law was described by Justice Perkins in Goodyer v. Goodyer:

Spouses are not usually trustees for each other in their dealings with property during the marriage...Their dispositions of property generally within a marriage...are not wrongful appropriations of trust funds. Tracing is a fault based concept applied after the fact in family law to a series of transactions that were never wrongful and have not become so by reason of the separation of the spouses. The tracing concept was adopted because the Family law Act property scheme has a bias in favour of sharing the value of assets in existence at the separation date and a bias against the exclusion of assets from the equalization calculation [emphasis added]. Hence the onus on the spouse seeking to exclude assets, and hence the requirement that the spouse seeking to exclude a gift received during the marriage be able to trace it from its original form into assets in existence at the separation. 1

This has allowed for arguments that the traditional tracing rules can be relaxed in matrimonial cases. In Farrell v. Farrell, the wife claimed an exclusion for the amount of her mutual fund portfolio that she said

1 Goodyer v. Goodyer, [1999] O.J. No. 29, 1999 CarswellOnt 37 at para 65 (Ont. Gen. Div.).

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consisted of monies her parents gifted her throughout her marriage, $284,631.40.2 The wife and her brother gave evidence of gifts received from their parents and that their parents were careful to be fair and to benefit both equally. The brother gave evidence that he received $120,000 to $150,000. Justice O'Connor accepted that the parents gave equal amounts to the wife and that she invested the money in the mutual fund portfolio. The wife was unable to determine the exact amount received or to identify how much of the mutual funds had been earned as interest.3 She spent some of the funds on gifts and household items and contributed some amounts to the mutual funds from other sources. The wife cited Goodyer v. Goodyer for the proposition that tracing in matrimonial cases is not for rectifying the wrongful disposition of trust property and so the tracing rules should be relaxed.4 The Court found that the wife was not permitted to exclude the whole of the amount in the mutual funds but found that she received the same amount as her brother, $150,000,and was entitled to exclude that amount.5

Method of Tracing

There have been three suggested methods for tracing: the "first in, first out" method from Clayton's Case; the pro rata method; and the common sense method.

Clayton's Case

In Mittler v. Mittler the Ontario Supreme Court adopted the "first in, first out" principle first established in the 1816 English case, Clayton's Case.6 According to this method, monies first deposited into accounts are the first monies to be withdrawn.

For example, $100 of excluded funds are deposited into an account and $100 of non-excluded funds are subsequently deposited into the same account. $50 is withdrawn with $150 remaining on the date of separation. Using the "first in, first out" method, the value of the excluded funds would be $50, since those funds were first deposited, and the value of the non-excluded funds would be $100.

The Ontario Court of Appeal addressed whether the "first in, first out" rule should be applied to competing beneficial entitlements in mingled trust funds in Ontario {Securities Commission) v. Greymac Credit Corp.7

In that case, a trustee deposited funds from two beneficiaries into a single account. The trustee then made unauthorized disbursements from the account resulting in insufficient funds to fully reimburse each beneficiary. The Court found that the application of Clayton's Case to mingled trust funds was arbitrary and unfair.8 The Court chose to use the pro rata method, finding it to be more logical and just.

It was noted by the Superior Court of Justice in Paddock v. Paddock and affirmed on appeal that the "first in, first out" has been replaced by the other methods and is no longer used to trace funds.9

2 Farrell v. Farrell, [2002] O.J. No. 3614, 2002 Ca rswellOnt 3096 at pa ra 19 (Ont. S.C.J.). 3 Farrell, ibid. 4 Farrell, ibid. 5 Farrell, ibid. 6 Mittler v. Mittler, [1988] O.J. No. 1741, 1988 Ca rswellOnt 303 (Ont. S.C.). 7 Ontario (Securities Commission) v. Greymac Credit Corp., 55 O.R. (2d) 673, 1986 Ca rswellOnt 158 at pa ra 37 (Ont. C.A.) (Greymac). 8 Greymac, ibid at pa ra 41. 9 Paddock v. Paddock, [2008] O.J. No. 5746, 2008 Ca rswellOnt 8794 at pa ra 37 (Ont. S.C.J.), aff'd 2009 ONCA 264, 2009 Ca rswellOnt 1593.

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3

Pro Rata Method

The pro rata method from Greymac was adopted in the family law context in Goodyer. The Court stated that "if Ontario Securities Commission v. Greymac Credit Corp. represents the law of tracing generally in trust cases, on the basis that a pro rata approach is more sensible and just, it must also be the law for family cases where tracing is to be carried out under subsection 4(2) of the Family Law Act.,, 10

Using the pro rata method in the example above (on p. 2 - Clayton1s Case), the value of the excluded and non-excluded funds would be $75 each. Equal amounts of excluded and non-excluded funds were contributed to the account so the remaining funds are split equally between excluded funds and non- excluded funds.

The pro rata method is usually used to determine the amount of excluded funds when those funds have been mixed in bank accounts. In Henderson v. Casson, the Court adopted Goodyer in determining the amount of excluded funds in a mixed bank account and found that tracing should proceed on a pro rata basis because there were many transactions over a period of time with no documentation as to which funds the party was intending to use.11

Common Sense Method

The common sense method is commonly used when property is purchased shortly after an inheritance or gift is received and due to the financial position of the family, it is reasonable to link the purchase to the inherited or gifted funds.

This method was used in Bennett v. Bennett when the Court found that the proximity between receiving an inheritance and purchasing the property were such that, on a reasonable balance of probabilities, the inherited funds were used for the purchase.12 In that case the husband received a $40,000 inheritance from his mother and a plot of land was purchased at about the same time for $35,000. There was evidence of the funds being paid out but no evidence of where they went. The husband gave evidence that the funds likely went into the family1s joint account, however, the receipt of the inheritance and the purchase of land was very close in time. Although strict tracing rules would not allow for the exclusion, a common sense approach looking at how the family could have afforded the purchase without the inherited funds led to the conclusion that excluded funds were used for the purchase.13

The common sense reasoning from Bennett was adopted in Henderson v. Casson. In Henderson, the husband borrowed funds from his company to pay his previous wife a lump sum. The husband could not repay the money prior to the end of the following fiscal year so he declared a dividend for a portion of the borrowed amount. The rest of the borrowed amount was repaid with his current wife1s inherited money. It was agreed that the husband would pay her back with interest. The wife claimed an exclusion for the loaned amount, although the inheritance had been mixed in her bank account with other funds. The wife1s evidence was that she would not have made the loan if she had not received the inheritance. The

10 Goodyer, supra note 1at para 70. 11 Henderson v. Casson, 2014 ONSC 720, 2014 CarswellOnt 1259 at para 95. 12 Bennett v. Bennett, [1997] O.J. No. 4768, 1997 CarswellOnt 4682 (Ont. Gen. Div.). 13 Bennet, ibid at para 86.

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4

proximity of receiving the inheritance and making a loan was sufficient on a balance of probabilities to prove that the inherited funds were used for the loan.14

Tracing Through Multiple Transactions

Excluded property can be traced through a number of transactions and changes in the form ofthe asset.15

At each stage, the question is whether the beneficiary can show that trust property was used to acquire subsequent property or proceeds that are in existence on the valuation date.16

Tracing only comes to an end when the beneficiary is unable to prove the necessary connection between the trust property and the subsequently acquired asset.17 Where there is clear documentary evidence of the transformation of an excluded asset into other identifiable property, the exclusion is preserved.18

Tracing Forward

It is commonly held that tracing can only proceed forwards in time. A claimant cannot trace funds back to an asset that was purchased prior to receiving the excluded funds. Rosenthal v. Rosenthal is often cited for this proposition.

In Rosenthal, the husband received legal title to shares and in return executed a promissory note.19

Portions of the promissory note were to be forgiven over time. The husband argued that the shares were a gift and therefore were excluded property. The Court was asked to trace the forgiveness of portions of the demand note back to the shares the husband had received to establish that the shares were a gift.20

The Court found that it cannot trace backwards - the husband already had legal title to the shares before receiving forgiveness for portions of the note so tracing could not be used to establish that legal title.21

Goodyer involved similar facts. In Goodyer, the husband claimed an exclusion for the money used to buy his boat, however, when the husband bought the boat the money was a loan not a gift. The loan was forgiven the following year which increased the husband's net worth but it did not go towards the acquisition of the boat. The husband already owned the boat when he received the gift and so could not trace the gift to the boat.

The opposite result was reached in Allgeier v. Allgeier.22 In Allgeier the husband argued that he bought a condominium with inherited funds. The husband borrowed money from his mother-in-law when buying the condominium because his inheritance money was tied up in a GIC which he did not want to redeem and pay the financial penalty.23 As soon as the husband's GIC was redeemed, he repaid his mother-in-law

14 Henderson, supra note 12 at para 91. 15 Ludmer v. Ludmer, 2013 ONSC 784, 2013 CarswellOnt 1625 at para 85 (Ont. S.C.J.). 16 Ludmer, ibid at para 85. 17 Ludmer, ibid at para 86. 18 Ludmer, ibid at para 87. 19 Rosenthal v. Rosenthal, [1986] O.J. No. 2520, 1986 CarswellOnt 288 (Ont. S.C.). 20 Rosenthal, ibid at para 50. 21 Rosenthal, ibid. 22 Allgeier v. Allgeier, [1996] O.J. No. 3956, 1996 CarswellOnt 4360 (Ont. Gen. Div.). 23 Allgeier, ibid at para 11.

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with the inherited funds. The Court found that that was sufficient tracing to trace the inheritance money to the condominium and on the sale of the condominium, the amount received was excluded.24

Allgeier has been considered but not adopted in subsequent cases.

Tracing from Joint Account

Generally, once excluded funds have been deposited into a joint account, half of the exclusion is lost due to the operation of s. 14 of the Family Law Act which provides:

14. The rule of law applying a presumption of a resulting trust shall be applied in questions of the ownership of property between spouses, as if they were not married, except that,

(a) the fact that property is held in the name of spouses as joint tenants is proof, in the absence of evidence to the contrary, that the spouses are intended to own the property as joint tenants; and

(b) money on deposit in the name of both spouses shall be deemed to be in the name of the spouses as joint tenants for the purposes of clause (a).

In Colletta v. Colletta the parties had a joint account that contained monies from the husband1s mother.25

The trial judge found that the account was the sole property of the husband as it only contained monies from the estate of the husband1s mother and as such, excluded the full amount of the monies in the account from the husband1s net family property. The Court of Appeal overturned this finding. As the account was a joint account, there was a presumption that the parties had an equal interest in the account. The Court of Appeal found that the wife owned half of the monies in the account, with interest. The husband had used up the monies in the account so the equalization payment owing by the wife to the husband was reduced by half of the value of the joint account.

In Belgiorgio v. Belgiorgio the husband sought to exclude the portion of his inheritance that was deposited into a bank account held jointly with his wife.26 Justice Beaulieu considered the presumption created by s. 14 of the Family Law Act that monies deposited into a joint bank account are intended to be jointly owned. The Court held that the husband was unable to rebut the presumption of advancement under s. 14 and he lost the exclusion once the inheritance funds were deposited into the joint account.27

In Townshend v. Townshend the husband claimed an exclusion for a $25,000 inter vivos gift that his wife had deposited into a joint account, contrary to his instructions.28 The trial judge found that the funds fully lost their exclusionary character when deposited into a joint account.29 The Court of Appeal accepted the trial judge 1s rejection of the husband1s evidence that the funds were deposited into the joint account contrary to his instructions but found that the husband should have been granted an exclusion for one- half the value of the funds. 30 The Court considered Belgiorgio, relied on by the wife for the proposition

24 Allgeier, ibid. 25 Colletta v. Colletta, [1993] O.J. No. 2537, 1993 CarswellOnt 359 (Ont. C.A.). 26 Befgiorgio v. Befgiorgio, [2000] O.J. No. 3246, 2000 CarswellOnt 3060 at para 31 (Ont. S.C.J.). 27 Belgiorgio, ibid at para 35. 28 Townshend v. Townshend, 2012 ONCA 868, 2012 CarswellOnt 15604 at para 17. 29 Townshend, ibid at para 30 Townshend, ibid at para 19.

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38 Lovich, ibid at para 34.

6

that a gift loses its exclusionary character completely when deposited into a joint account and Colletta, for the proposition that a gift loses its exclusionary character to the extent of one-half when deposited into a joint account.31

The Court followed the proposition set forth in Colletta but did not agree with the method used by that Court to calculate the amount owing to the husband - deducting the full amount of the non-excluded funds from the equalization payment owed by the wife to account for the husband's loss of half of the exclusion. The Court found that by subtracting the full value of the monies in the account owned by the wife from the equalization payment owing by the wife, the husband was deprived of the value of his exclusion in Colletta.32

Practically speaking, both methods result in the same amount being owed to the husband, unless the husband only had excluded property. It is likely that the Court in Townshend took issue with the Court in Colletta accounting for funds the husband had already received in the calculation of the equalization payment rather than calculating the equalization payment then accounting for the funds received.

The Belgiorgio, Colletta and Townshend decisions were considered and distinguished by the Ontario Superior Court of Justice in Cortina v. Cortina.33 In Cortina, the husband claimed an exclusion for money inherited from his mother that was in a solely owned investment account at the date of separation. Prior to the date of separation and being placed into a solely owned account, the inherited funds were deposited into an account held jointly with the wife. Interestingly, the Court found that the husband never intended to gift the funds to the wife and they were only placed in the joint account until the husband decided what to do with them and the presumption set out in s. 14 of the Family Law Act was rebutted.34 Factors that led to the conclusion that the presumption was rebutted included: the wife had no access to the investment account; the funds were not used for anything other than occasionally paying family debts; there was no evidence that money other than the inherited funds were deposited into the investment account and the funds were moved by the husband years before separation.35 The Court rejected the wife's argument that the funds lost their exclusionary character by virtue of passing through the joint account and allowed the husband to exclude the full value of the investment account funds.36

Tracing Through Depreciable Property

Methods for tracing depreciable property were discussed in Lovich v. Lovich.37 In that case, the husband had been gifted farm equipment which had been traded in for new equipment throughout the course of the marriage. The Court canvassed three possible methods to trace the gift. The first method, "first in, first out", assumes that the value of the equipment brought into the marriage or gifted is the first value used up.38 Even if the equipment is traded in, the exemption is lost because it is assumed that the value of the equipment is consumed over the normal lifetime of the piece of equipment. The second method

31 Townshend, ibid at para 21. 32 Townshend, ibid at para 26. 33 Cortina v. Cortina, 2014 ONSC 5321, 2014 CarswellOnt 19168. 34 Cortina, ibid at para 342. 35 Cortina, ibid at paras 346-348, 362-363. 36 Cortina, ibid at paras 364, 366. 37 Lovich v. Lovich, 2006 ABQB 736, 2006 CarswellAlta 1312.

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42 Lovich, ibid at pa ra 46.

7

is to assume that the exempt value is carried forward in perpetuity and is deemed never to be consumed.39

A final method is to assume that the exempt value of the original asset is consumed pro rata with the replacement. As the replacement asset is consumed over time, it would be assumed that the original exempt value is consumed pro rata.40

In determining the appropriate method, the Court found that the cases are clear that the exemption can be lost if exempt assets are dissipated or so co-mingled with matrimonial assets that they can no longer be identified.41 This principle can be applied to depreciable assets.

The Court found that where depreciable exempt property is consumed during the marriage, the following principles should apply:

(a) The initial exempt value is the fair market value of the depreciable property on the date of the marriage or the date of the gift.

(b) The exemption can be carried forward if the property is traded in, or if the property is sold

and replaced. The exempt value can be traced forward into new property so long as there is a reasonable nexus between the exempt property and the replacement property. No precise and exact tracing is required and de minimis breaks in the chain of exempt property can be tolerated.

(c) The amount of the exemption is lost if the property is consumed up or depreciated. If, by the

time of trial, the property has been totally consumed and depreciated, there is no remaining exempt value.

(d) If the property is partly consumed and depreciated, and then traded for other property, the

value at the date of the trade-in is carried forward into the new property. If that new property is then consumed or depreciated, the exempt portion is deemed to be consumed pro rota with the non-exempt portion.42

Lovich is an Alberta Court of the Queen's Bench case and so it is only persuasive in Ontario.

39 Lovich, ibid at pa ra 35. 40 Lovich, ibid at pa ra 36. 41 Lovich, ibid at pa ra 44.

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TAB 4B

Date of Marriage Assets and Liabilities

Alla Levit, CA, CPA, CBV, IFA Levit Valuations Inc.

June 19, 2017

THE ANNOTATED Financial Statement for

Family Law Lawyers

THE ANNOTATED FINANCIAL STATEMENT

DATE OF MARRIAGE ASSETS AND LIABILITIES AND

EXCLUDED PROPERTY June 19, 2017

ALLA LEVIT, CPA, CA, CBV, IFA LEVIT VALUATIONS INC.

Business Valuations and Litigation Support Tel (416) 489-7175

Email: alla@levitvaluations.com Website: www.levitvaluations.com

Date of Marriage Assets and Liabilities

• Date of marriage deduction vs. excluded property deduction

Gifts / inheritances before marriage vs. during marriage

• Difference between determining assets and liabilities at date of marriagevs. date of separation

Same methodology, except:

- can’t deduct value of matrimonial home at date of marriage

- beware - can have more than one matrimonial home

• Date of Marriage documents

- may not be available due to passage of time

• Onus of proof- on the spouse claiming the date of marriage deduction

• Sources of information for date of marriage deduction, if traditionalsources not available

Personal tax returns prior to and after date of marriage: Dividends – share ownership Capital gains – share ownership, real estate ownership, etc. Interest income – extrapolate bank balances at date of marriage Rental income – real estate ownership Rental interest expenses – debt at date of marriage

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Carrying charges and interest expenses – debt against investments RRSP contributions – RRSP minimum value Tax shelters – contingent liabilities

Real estate searches Real estate owned at date of marriage Mortgages, other debt registered against the real estate

Loan applications, net worth statements

Marriage contracts

Date of Marriage Liabilities

• Don’t forget the liabilities at the date of marriage, including contingentdisposition costs

• Use the tax rates applicable at the date of marriage

• Use capital gains inclusion rate applicable at date of marriage

• 1995 Reserve

• Unused capital gains exemption at the date of marriage

• Present value of tax liability may be lower at date of marriage due to longerperiod of discounting (may be offset by higher discount rate)

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Excluded Property

Family Law Act Section 4(2) - The value of the following property that a spouse owns on the valuation date does not form part of the spouse’s net family property:

- owned at valuation date – if funds spent/property gone, exclusion lost

1. Gifted or Inherited Property – Property, other than a matrimonial home,that was acquired by gift or inheritance from a third person after the date ofthe marriage.

- other than a matrimonial home – exclusion lost if funds used for matrimonial home

- third person - gifts between husband and wife don’t count - after the marriage – gift before marriage not an exclusion, but

date of marriage deduction

2. Income from Gifted or Inherited Property - Income from property inparagraph 1, if the donor or testator expressly stated it is to be excluded fromthe spouse’s net family property

– what is income from property?

3. Damages - Damages or a right to damages for personal injuries, nervousshock, mental distress or loss of guidance, care and companionship, or thepart of a settlement that represents those damages

4. Proceeds of Life Insurance - Proceeds or a right to proceeds of a policy oflife insurance, as defined in the Insurance Act, that are payable on the deathof the life insured

5. Traced Property - Property, other than a matrimonial home, into whichproperty referred to in paragraphs 1 to 4 can be traced

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6. Property Agreed to in a Domestic Contract - Property that the spouseshave agreed by a domestic contract is not to be included in the spouse’s netfamily property.

7. Unadjusted pensionable earnings under the Canada Pension Plan.

• Burden of Proof - Subsection 4(3) of FLA

- The onus of proving a deduction under the definition of “net family property” or an exclusion under subsection (2) is on the person claiming it.

• Tracing is Prospective (not retrospective)- Must trace forwards from time of gift/inheritance to date of

separation, not backwards.

Excluded Property - Tracing Approaches

• First in First Out (“FIFO”)

• Pro-rata

• Lowest Intermediate Balance Rule (“LIBR”)

• Common sense

• Gross Value vs. Equity

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Excluded Property Tracing Approaches

FIFO Approach $80,000 total exclusion

Excluded Non-

Excluded Total Percentage Excluded

Opening balance $ 25,000 25,000 0% Inheritance deposit

100,000 100,000 100%

Purchase of investment

(75,000) (25,000) (100,000) 75%

Balance 25,000 0 25,000 0% Living expenses (20,000) (20,000) 100% Closing balance $ 5,000 0 5,000 100%

Pro Rata Approach $84,000 total exclusion

Excluded Non-

Excluded Total Percentage Excluded

Opening balance $ 25,000 25,000 0% Inheritance deposit

100,000 100,000 100%

Balance 100,000 25,000 125,000 80% Purchase of investment

(80,000) (20,000) (100,000) 80%

Balance 20,000 5,000 25,000 80% Living expenses (16,000) (4,000) (20,000) 80% Closing balance $ 4,000 1,000 5,000 80%

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Excluded Property Tracing Approaches

Common Sense Approach $100,000 total exclusion

Excluded Non-

Excluded Total Percentage Excluded

Opening balance $ 25,000 25,000 0% Inheritance deposit

100,000 100,000 100%

Purchase of investment

(100,000) (100,000) 100%

Balance 0 25,000 25,000 0% Living expenses (20,000) (20,000) 100% Closing balance $ 0 5,000 5,000 100%

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Excluded Property –Gross Value vs. Equity

Gross value approach $150,000 total exclusion

Excluded Non-

Excluded Total Percentage Excluded

Inheritance $ 100,000 100,000 100% Debt 300,000 300,000 0% Purchase of investment

100,000 300,000 400,000 25%

Increase in value 50,000 150,000 200,000 25% Value at date of separation

$ 150,000 450,000 600,000 25%

Equity approach $300,000 total exclusion

Excluded Non-

Excluded Total Percentage Excluded

Inheritance $ 100,000 100,000 100% Debt 300,000 300,000 0% Purchase of investment

100,000 300,000 400,000 100%

Increase in value 200,000 0 200,000 100% Value at date of separation

$ 300,000 300,000 600,000 100%

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Excluded Property – Other Issues

• Jointly held property- Generally lose half the exclusion - Unless spouse is holding in trust

• Debt- Paying down debt with excluded funds – exclusion lost

• Contingent disposition costs- Must be deducted in calculating net exclusion

• Reorganizations/Estate Freezes- Estate freeze after date of marriage - Estate freeze before date of marriage - Trusts

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