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| Self-Employment Income in Family Law: To Deduct or Not to Deduct, That Is The Question |
When the Child Support Guidelines (“Guidelines”) were introduced in 1997, the federal and provincial governments legislated that its purpose was “to reduce conflict and tension between parents or spouses by making the calculation of child support more objective.” The idea was that separated parents could simply look up the income of the parent paying support, and the number of children supported, and this would easily determine the exact monthly dollar amount of child support payable. This legislation was supposed to end the controversy, litigation and cost of determining the amount of child support. Not so fast.
Although this intent became true for support payors who were salaried or hourly employees, there were many support payors who owned businesses and exercised discretion as to the income they reported to Canada Revenue Agency (CRA).
According to Statistics Canada, over 15% of Canadians, or nearly 3 million people, are self-employed (Source: Statistics Canada, Labour Force Survey, April 2012). In an era where nearly half of all marriages end in separation, it is understandable why protracted litigation persists over the determination of separated parents’ income and the concomitant support obligations. Add to this the growing number of separating parents who are choosing to share custody after separation. In such a situation, both spouses could be treated as support payors, thereby necessitating an inquiry into both parents’ incomes pursuant to section 9 of the Guidelines (shared custody). Moreover, even if only one parent is the support payor and the other parent is the support recipient, the recipient’s income must also be evaluated for the purposes of proportionately sharing the children’s special and extraordinary expenses, including daycare, uninsured health care costs, private school tuition and university costs.
Indeed, the legislators were aware of this dilemma. Even though section 16 of the Guidelines directs that annual income is determined by Line 150 of the payor’s income tax return under the heading “Total Income”, section 19(2) goes on to state that “the reasonableness of an expense deduction is not solely governed by whether the deduction is permitted under the Income Tax Act.” In other words, the fact that a business expense is legitimate for tax purposes does not mean that the same deduction is reasonable for support purposes (Cook v. Cook [2011] O.J. No. 4399).
Chartered Business Valuators (CBV’s) have educated the bar as to the many methods they employ to ascertain the payor’s income for the purposes of calculating support. These tools include:
-collecting, analyzing and reporting on the payor’s financial records including the business’ Financial Statements (if incorporated) and Statement of Business/Professional Activities (if a sole-proprietorship or partnership). These records provide a good source of data that are used to add back to income any expenses deducted that were incurred for the owner’s personal benefit, deductions that are not provable, retained earnings and/or shareholder loans
-comparing and analyzing the family’s lifestyle costs versus their reported income to demonstrate that more income than reported must exist to support the family’s historical cost of living
-collecting records from other sources where the payor reported his/her income such as applications for loans, mortgages and credit, applications for government benefits and applications for life and disability insurance
-public data from Statistics Canada’s Wage Book and the Financial Services Commission Wage Table illustrating wage ranges
-public data for other similar businesses illustrating the range of income for the subject business
CBV’s do great work in the Family law arena ascertaining the true income of support payors and reducing the number of cases that proceed to trial. For those cases that do reach trial, CBV’s can provide expert testimony to the court to assist in determining a party’s income.
Ultimately, the very conflict and tension that the Guidelines sought to eliminate become revisited when a support recipient seeks to impute a higher income to a self-employed support payor. Since most recipients cannot afford the cost of a CBV, the most common approach used by lawyers is to argue that certain expenses deducted from income were incurred for the owner’s personal benefit and, despite CRA’s decision to allow the deduction, should be added back to the payor’s income in order to calculate child support, as permitted under section 19(1)(g) of the Guidelines.
Some judges will respect the findings of CRA and not impute income on the basis that the court should respect the right of self-employed persons to run their business as they see fit (Osmar v. Osmar 2000 CanLII 22530 (ON S.C.)). Conversely, some judges will question whether particular expenditures ought to be allowed to reduce a support payor’s income and thereby reduce support.
How much will judges second-guess business owners as to their reported income and expenses ? The answer is case-specific.
For example, in determining the income of a self-employed lawyer in Toronto, the court recently found that “car expenses, rent/home office, travel, meals/entertainment, phone/internet, insurance and legal expenses all represent examples of expenses that should be added back to income for support calculation purposes” (Ludmer v. Ludmer [2013] O.J. No. 699). Not only are these amounts added back to income, they are then usually grossed up for taxes (Riel v. Holland (2003), 67 O.R. (3d) 417 (C.A.)). In Ludmer, the court even admitted that “there is no scientific or absolute means of determining the right balance of expense deduction to gross revenue…but [the court] is required to determine an income level that fairly and reasonably reflects the compensation available to the respondent to pay support.”
In cases such as these, counsel can best serve clients (both support payors and recipients) by forming an understanding of the accounting principles involved in business ownership and by knowing how to read and understand corporate financial statements and income and expense statements. For the support recipient, this will assist counsel to ask the right questions - whether in written form (under Rules 13 and 19) or during Questioning. For the support payor, this will allow counsel to gather and assemble the supporting source documents to validate the reported income. CBV’s should either be consulted or engaged in appropriate cases.
In the end, unless a settlement is reached, it is up to the court to determine a party’s income (and therefore support) based on what the parties can prove or cannot prove in the context of business deductions. |
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