February 23, 2022 – Attribution of Pre-Tax Corporate Income

“Reliance was placed by both parties on the case of Thompson v. Thompson, 2013 ONSC 5500, regarding the approach to be taken by the court when exercising its discretion in the determination of total income for support purposes.  In that case, Chappel J. observed that:

a.   Retained earnings are the cumulative net earnings of the corporation since the inception of the company less dividends paid out to shareholders since that time. They are the shareholders’ equity in the company, and do not necessarily represent cash in the bank that shareholders can take out as income. [at para. 89]

b.   The purpose of section 18 is “to enable the courts  to conduct a fair accounting of the money available for the payment of child support” and is “designed to address the unfairness which would result if a spouse was to artificially manipulate his income through a corporate structure for the purpose of avoiding child support obligations.” [at para. 88, citing Wildman v. Wildman(2006), 2006 CanLII 33540 (ON CA), 82 O.R. (3d) 401; Koester v. Koester (2003), 2003 CanLII 2150 (ON SC), 50 R.F.L. (5th) 78]

c.   The party proposing that corporate pre-tax income be attributed to the other party has the onus of demonstrating some basis upon which section 18 should be engaged. The fact that retained earnings remain in the corporation does not in and of itself require the party with the interest in the company to justify the business reasons for not withdrawing corporate pre-tax income or retained earnings. Once the party advancing the section 18 argument has met this onus, the party who has the interest in the corporation has the onus of explaining why the decision to add the corporate pre-tax income to the company’s retained earnings rather than withdrawing a portion of the earnings was reasonable from a business perspective. The rationale for this is that the shareowner will in all likelihood have a much greater appreciation of the workings and needs of the company, or will be best able to identify individuals who can be called as witnesses to address the issue.  [at para. 91]

d.   There are a variety of factors that the court can take into consideration in its determination of whether all or a portion of a corporation’s pre-tax income should be included in a spouse’s income, including the historical pattern for retained earnings, the nature of the industry that the corporation is operating in, business plans, level of debts, debt or other restrictions, whether salaries are on par with market, and whether there are legitimate business reasons for retaining earnings in the company, and the payor’s proportionate ownership interest in the company. [at paras. 92-93]

e.   The court must carefully consider “where and how additional money can be found from a corporation’s pre-tax income so as to increase a party’s income for the purpose of support calculations. … [F]ailure to properly understand this issue ‘can lead to an incorrect result and ultimately, if the parent cannot find the expected additional money, may undermine the operation of the corporation and eventually kill the goose that lays the golden egg.’” [at para. 90, citing Bembridge v. Bembridge, 2009 NSSC 158, 73 R.F.L. (6th) 147, at para. 37]

The applicant clearly has the initial onus to demonstrate that s. 18 should be engaged.  She maintains that she has met her onus by the respondent’s concession that some income must be attributed to him from the companies, even to come to the $440,000.00 adjusted income number that he propounds by virtue of inclusions for non-arm’s length salaries and benefits (as s. 18(2) provides for). The fact that he chooses to attribute only income associated with income splitting and benefits does not, according to the applicant, nullify the threshold that has been crossed into the s. 18 Support Guidelines considerations.

The adjusted annual income figure of $440,000.00 calculated by the respondent’s expert does not include pre-tax corporate income.   However, the income valuation report clearly recognizes that there is undistributed pre-tax corporate income in the companies.  The applicant’s initial onus is low and I find it has been met in this case.  Thus, it falls on the respondent to justify why some or all of the pre-tax corporate income should not be attributed to him.

As the court concluded in Thompson, at para. 91: “Once the party advancing the section 18 argument has met this onus, the party who has the interest in the corporation has the onus of explaining why the decision to add the corporate pre-tax income to the company’s retained earnings rather than withdrawing a portion of the earnings was reasonable from a business perspective.”

            Nani v. Nani, 2021 ONSC 1368 (CanLII) at 31-34