B. Relevance of Income Tax

• Author: Julien D. Payne - Marilyn A. Payne
• Pages: 2-7

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Prior to May 1, 1997, periodic child support payments made pursuant to a court order or written agreement after marriage breakdown were deductible from the taxable income of the payor under sections 60(b), 60(c), and 60.1 of the Income Tax Act¹and were taxable as income in the hands of the payee under sections 56(1)(b) and (c), provided that such payments were made to the custodial parent and not to the children directly.²As of May 1, 1997, Canada shifted to an income tax system whereby the payor no longer receives a deduction for payments made and the receiving parent no longer pays tax on child support received under any new order or agreement or pursuant to any variation made after April 30, 1997 of a pre-existing order or agreement.³The new tax rules do not apply to orders or agreements made before May 1, 1997 unless (a) a court order or agreement made on or after May 1, 1997 changes the amount of child support payable under an existing agreement or court order; (b) the court order or agreement specifically provides that the new tax rules apply to payments made after a specified date which cannot be earlier than April 30, 1997; or (c) the payor and the recipient have both signed and filed a form with the Canada Revenue Agency stating that the new tax rules apply to payments made after a specified date that cannot be earlier than April 30, 1997.⁴The income tax consequences of child support agreements and orders made before May 1, 1997 generated significant savings for many families encountering divorce and will continue to do so until they are superseded by new agreements executed or orders granted after May 1, 1997.⁵Variation of a pre-Guidelines agreement after May 1, 1997 attracts the new income tax regime and payments falling due after the variation are payable in after-tax dollars.⁶With the implementation of the Federal Child Support Guidelines, a court is not authorized to vary an order piecemeal by merely tacking on special or extraordinary expenses to a pre-existing order. The order, if varied, must

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be varied in accordance with the Guidelines and this automatically triggers the new tax regime under which child support payments are no longer deductible from the payor’s taxable income nor are they taxable as income in the hands of the recipient spouse or former spouse.⁷Even a minor variation of child support arrangements that predate the implementation of the Guidelines will trigger the new income tax regime.⁸Although the statutory definition of "commencement day" in section 56.1(4) of the Income Tax Act could have been more clearly drafted, its underlying intention is that only orders or agreements made after April 1997 that create new child support obligations will be subject to the new income tax regime whereby periodic child support payments are no longer deductible from the taxable income of the payor nor taxable in the hands of the payee. Where an order for child support granted after April 1997 merely mirrors an order and minutes of settlement executed long before the new income tax regime came into effect, the old deduction/inclusion income tax regime continues to operate.⁹An increase in child support payments that was already provided for in a pre-Guidelines consent order does not affect the income tax status of the payments made and received.¹⁰A retroactive variation order for child support that operates back to May 1, 1997, the date on which the Federal Child Support Guidelines and amendments to the Income Tax Act were implemented, converts a pre-Guidelines order in such a way as to attract the new income tax regime with respect to payments falling due after May 1, 1997. Such payments are made in after-tax dollars; they are not deductible from the taxable income of the payor. The payments made before May 1, 1997 remain deductible.¹¹If an agreement is entered into after April 30, 1997, which changes the child support payable, the original agreement as varied will fall subject to the new tax regime,¹²even though no income tax change was foreseen by the parents or their lawyers.¹³Once the tax treatment of child support payments has been changed to the new "no deduction, no inclusion" tax regime, parties cannot revert to the former tax based regime. A court may order child support arrears under a pre-Guidelines order to be paid in monthly instalments and to remain deductible from the taxable income of the payor and taxable as income in the hands of the recipient. The fixing of arrears is not to be confused with a variation of the order; only the latter intervention triggers the new tax regime.¹⁴Where variation of a pre-Guidelines child support order is required because of a substantial increase in the obligor’s income, the obligor cannot obtain an order couched in language that would compel an additional payment without characterizing that payment as child support, even if the obligor is prepared to gross up the order by the amount of his tax saving attributable to the pre-Guidelines order. An obligor cannot enlist the aid of the court to torture the language of the applicable statute so as to confer an unwarranted advantage on the obligor in his capacity as a taxpayer.¹⁵

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Periodic child support payments made pursuant to a court order granted before May 1, 1997 are taxable income in the hands of the recipient parent even though the payments are received after the aforementioned date when amendments to the Income Tax Act and the Federal Child Support Guidelines were implemented.¹⁶Support payments do not change in character as a result of not being made on time and on a periodic basis as required by the judgment or agreement under which the amounts are payable. Arrears of support are taxable in the taxation year in which they are received, not in the taxation year when they first fall due.¹⁷A lump sum payment made in partial satisfaction of periodic child support obligations owed under a pre-Guidelines order remains taxable in the hands of the recipient even though received after May 1, 1997, the date on which the Federal Child Support Guidelines were implemented together with consequential changes to the income tax regime. The fact that the divorce judgment expressly stipulates that the periodic child support payments shall not be taxable in the hands of the recipient cannot override the express provisions of the Income Tax Act to the contrary.¹⁸The tax changes do not apply to periodic spousal support payments which continue to be deductible from the income of the payor and constitute taxable income in the hands of the payee.¹⁹Before May 1, 1997, lawyers and courts sometimes arranged or ordered a global amount of spousal and child support without apportioning the amount payable to each category of dependant. Such global amounts were commonly used by lawyers and courts when dealing with interim support. This practice should be abandoned²⁰as a consequence of the new tax rules respecting child support because an amount in a written agreement or court order that is not identified as being solely for the support of a spouse will be treated as child support for income tax purposes.²¹Similarly, where a written agreement or court order provides that certain expenses are to be paid directly to a...