In family law, few things are more important after a marital breakup then establishing appropriate child support. For uncomplicated calculations, the Federal Child Support Guidelines (“Guidelines”) are usually invoked. When a closely held corporation is involved it gets much more complicated.
Child support is usually paid when one of the parents has primary care and residence of the child and/or one of the parties has an income that is larger than the other. It is usually payable until the child turns 18 or they cease to be a “child of the marriage”. Without getting too far afield, a child may still be a “child of the marriage”, for example, if they continue to reside with a parent while attending university full time.
When someone is in a standard employee/employer arrangement, their line 150 income from their income tax statement is usually used to calculate child support obligations. However, in situations where the paying party earns income through their closely held corporation the answer may not be as simple. This area of law has seen frequent changes over the last number of years, but the decision in Holtzman v. Holtzman sheds some light on how to assess child support when considering these businesses structures.
Mr. Holtzman left his employment in 2008 and received a severance payout payable over the next three years. In 2008 he incorporated a company for which he was the sole shareholder and director. Between 2008 and May, 2012 almost all of Mr. Holtzman’s income had been drawn from the corporation in the form of salary or dividends. In the first of a trilogy of decisions in this matter, the judge considered Mr. Holtzman’s salary, income tax deductions for meals/rent/entertainment expenses and retained earnings in the corporation to assess his total income. The judge considered the portion of severance pay from Mr. Holtzman’s previous employment to be non-recurring income and did not include it. This first Holtzman decision confirms that courts are willing (and in fact statutorily required) to look beyond the individual salary earned by a payor. Here, the Court did look to the corporation and included not a portion but the entire retained earnings of the corporation and other business related income as well.
The second Holtzman case came 9 months later when the husband applied to vary the earlier decision. Based on the same facts, the judge included as income Mr. Holtzman’s salary, actual dividends, increase in retained earnings, meals/rent/entertainment expenses, and severance from his previous employment and subtracted the allowance for dividends received in the previous year. This second decision is important for two reasons. First, the Justice did include the severance pay from Mr. Holtzman’s previous employment as income. The reason was that at the time of the first decision Mr. Holtzman had invested all of the severance pay in his RRSP; when the second matter was heard, Mr. Holtzman had invested less than half of the severance payment in his RRSP. This variance from year to year was seen as an acceleration in income. Secondly, the Court only considered the increase in retained earnings in the corporation rather than the entirety of the earnings for that year in effort to avoid the danger of double counting items that had already been included in the previous decision.
Just months ago, this matter came before the Court one more time. The court in the final Holtzman decision differed from the previous two by focussing on pre-tax income rather than retained earnings. Pre-tax income is, as the name suggests, the net pre-tax earnings of a corporation for a given tax year, while retained earnings are the accumulated profits of the corporation after tax and may include capital and non-cash assets. The Justice decided to use the company’s pre-tax income and did not deduct from the severance payment Mr. Holtzman’s RRSP contributions, nor did he exclude a 2013 withdrawal of RRSP income. Given the fluctuations in income, the court used an average of the last three years total income to assess appropriate child support.
Based on these decisions, courts seem consistent in valuing closely held corporations for the purpose of child support. The entire value of the pre-tax earnings of a corporation is considered an appropriate starting point. It is the payor’s responsibility to show the court why these pre-tax earnings are inappropriate given the specific circumstances of the corporation. Evidence of expected capital expenditures in the following year or an expected downturn in a specific industry may be helpful on this point. Our courts will also likely consider any other personal income the payor has amassed, whether or not this income is deferred partially or completely. Finally, if a payor’s income is inconsistent from year to year, the Court may choose to average the past three years to assess the appropriate level of support.
Although a corporation can act as a shield from its directors’ liabilities, courts are now clear that in a child support scenario, the corporation is a very weak shield.
This article originally appeared in Saskatchewan Business magazine. It is reprinted with their kind permission