Deemed Dividends: How Is Child Support Calculated?

How is child support calculated where the payor parent has unusual forms or patterns of income or is able to manipulate their income for tax purposes? For example, in Andreassen v. Andreassen, 2016 BCSC 1196 the court was asked: how is child support calculated when it comes to dividend income? In that case, the recipient parent sought a determination that money received by a corporation owned by her ex-husband which was treated as a “deemed dividend” for tax purposes formed part of his income for determining his child support obligations pursuant to the Federal Child Support Guidelines, SOR 97-175 (the “Guidelines”).

Ultimately, when it comes to how child support is calculated, the court must to focus on the substance of any transaction or mode of receiving income rather than the form of any payments to a corporation. After an analysis of the transactions and the true nature of the sum received, Armstrong J. concluded that the deemed dividends were not income under the Guidelines for child support purposes.

Divorce and child support order

The parties were married in 1996 and divorced in February 2005. Their children were born in 1998 and 2000. They share joint custody and guardianship but the children resided primarily with their mother since separation. Mr. Andreassen paid child support pursuant to a court order, which was modified several times in the years following the divorce.

Transactions resulting in deemed dividends

In June 2007, Mr. Andreassen’s parents undertook an estate plan to facilitate the transfer of their corporate wealth to Mr. Andreassen and his two siblings. As part of that plan, Mr. Andreassen and each of his siblings received one common share in their parents’ holding company, MHL. Mr. Andreassen created a personal holding company, Eastmere Holdings Ltd. (“Eastmere”), of which he was the sole director and shareholder. Eastmere acquired Mr. Andreassen’s common share in MHL in exchange for 100 common shares in Eastmere issued to himself. After the transfer of the MHL share to Eastmere, those shares were purchased by MHL for cancellation and, as part of this capital transaction, Eastmere received $1,250,000 from MHL in 2008. This part of the estate plan resulted in the proceeds being deemed dividends to Eastmere for the purposes of its 2008 taxes. Eastmere paid a refundable tax of $428,000 in 2008.

How is child support calculated when it comes to dividend income?

The issue for the court was whether the deemed dividend of $1,250,000 received by Eastmere should be construed as income available to support Mr. Andreassen’s children.

Opinion evidence on how child support is calculated

Both parties tendered opinion evidence concerning the treatment of dividend income under the Guidelines. Armstrong J. reviewed and commented on the expert reports, but was definitive in stating that the interpretation and application of the Guidelines are questions of law which are not properly opined upon in an expert report.

How is child support calculated under the Guidelines?

The court must characterize amounts in accordance with the following principles:

• The starting point in determining the measure of income for calculating child support is the income set out at line 150 of a parent’s tax return (per s. 16 of the Guidelines).

• From there, Schedule III of the Guidelinesgives the court discretion to adjust this amount to reflect funds the payor parent has at their disposal for child support purposes. The court must exercise its discretion in accordance with the objectives set out in s. 1 of the Guidelines.

• Where parties have unusual forms or patterns of income, or where they are able to manipulate their income for tax purposes in a manner that might frustrate the goals of the Guidelines, 17-19 allow courts a degree of flexibility:

Section 17 gives the court discretion to deal with the problem of income which fluctuates from year to year and with non-recurring income or losses such that the determination of a spouse’s income under s. 16 is not the fairest determination of that income. This provision permits the inclusion of non-recurring capital gains and the exclusion of non-recurring dividends.

Section 18 provides discretion to deal with the situation where a spouse is in a position to manipulate income in his or her capacity as shareholder, director, or officer of a corporation, such that a person’s income under s. 16 does not fairly reflect all the money available to that spouse for the payment of child support. It permits the inclusion of pre-tax corporate income and benefits paid to non-arm’s length persons.

Section 19 addresses situations where the spouse’s disclosed income does not fairly reflect what should be paid in child support by permitting imputation of income in a variety of situations, including income which is tax exempt, under-utilized capital investments, and when there is a failure to provide income information.

Ultimately, when it comes to how child support is calculated, Armstrong J. emphasized the need to focus on the substance of any transaction or mode of receiving income rather than the form of any payments to a corporation: para. 62. The objective is to ensure that a payor’s income reflects the money reasonably available for child support purposes.

Capital sums excluded from Guidelines income

In order to give consistent treatment to spouses whose assets are held in corporations, returns of capital (as opposed to returns on capital) will often be excluded from Guidelines income, even if the return of capital is structured as a dividend. Capital sums are generally excluded from Guidelines income determinations because payor parents will not be expected to sell or dispose of a capital asset for the purpose of generating income unless the capital is capable of earning income and is not being used for that purpose: para. 81. The onus is on the payor parent to provide clear evidence of what business income or assets of the company are unavailable to the payor. The court should not have to ferret out the necessary information from inadequate or incomplete financial disclosure: para. 63.

Gifts as a basis to impute income

Although legislature intentionally did not include the receipt of gifts given in presumptive income, a court will consider whether the circumstances surrounding the particular gift are so unusual that they constitute an “appropriate circumstance” in which to impute income. In considering whether it is appropriate to include the receipt of unusual gifts in income, a court will consider a number of factors, including the regularity of the gifts, whether the gifts were part of the family’s income during cohabitation that entrenched a particular lifestyle, the income generated by the gifts in proportion to the payor’s entire income, and whether the gifts are likely to continue.

Application of principles

Armstrong J. was satisfied that the transfers of wealth to Mr. Andreassen as part of his parents’ estate plan ought not be included in the his income for child support obligations, but the income earned by Eastmere on its investments was included in Mr. Andreassen’s income for the purposes of calculating child support.

The share transfer in the Andreassen case was clearly not income in the true sense of remuneration or payment for services, nor was it part of any regular or consistent plan to give money to Mr. Andreassen for his own use. The wealth transfer to Eastmere was a large, one-time gift accomplished through a scheme of share purchases and share redemptions as part of an estate planning scheme. Eastmere was merely a repository of funds given to Mr. Andreassen by his parents as part of their estate plan, and not in the nature of income flowing from a business venture or employment related activity. Although the wealth transfer resulted in the receipt of a deemed dividend by Mr. Andreassen’s corporation, Armstrong J. was satisfied the substance of the scheme was an inter vivos gift to Mr. Andreassen and not a source of income as contemplated in the Guidelines.

Eastmere’s capital was invested in income earning assets and it would be unreasonable to expect Mr. Andreassen to take into his personal income all of the capital given to him by his parents in the years. As long as Eastmere’s capital was appropriately invested to generate income, there was nothing in the circumstances of the gift which constitute the type of unusual circumstance described in s. 19(1)(h) of the Guidelines that would constitute an “appropriate circumstance” in which to impute income. However, if Eastmere’s capital was not prudently invested, then it may be appropriate to impute income that could reasonably be earned on the capital.

How is child support calculated? Take home point on deemed dividends

When it comes to how child support is calculated, the objective is to ensure that a payor’s income reflects the money reasonably available for child support purposes. Because the calculation of child support obligations generally depends on income rather than on property holdings, a payor parent’s capital is not considered money available for child support, but income earned on capital is conceptually available for that purpose. As such, capital sums will not typically affect the individual’s Guidelines income absent a capital gain or a failure to use property reasonably to generate income. For that reason, the court must analyze the substance of any transaction rather than the form of any payments.