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Some things just seem a little backward. Take my cousin Julia's situation for example. Julia is an environmentalist - a self-proclaimed "tree-hugger," to use her words. Her husband is a competitive swimmer. She doesn't shave her legs, but he shaves his. It just seems backward to me.

The folks at the Canada Revenue Agency (CRA) often take offence to things when they're backward. No, I'm not talking about personal grooming habits - CRA doesn't care much about whether or not you shave your legs. But CRA does care when someone else pays a tax bill and it should be you paying the tax instead.

The rules

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Let me tell you about subsection 56(2) of our tax law, which can cause real problems in certain situations. Specifically, this subsection will cause certain amounts to be taxed in your hands even when the amounts were received by someone else. Subsection 56(2) applies when the following conditions are met:

1. There is a payment or a transfer of property to a person other than you.

2. This payment is made at your direction, or with your concurrence.

3. There is a benefit to you, or a benefit you wish to confer on the other person.

4. You would have been taxable on the amount had you received the payment or transfer of property.

In situations where these conditions are met, subsection 56(2) will cause the amount to be taxed in your hands rather than the hands of the other person who received the amount. If subsection 56(2) applies, the amount in question will need to be added to your income; CRA will however reduce the income of the person who initially received the amount, in order to prevent double taxation.

The examples

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Clear as mud so far? Let me share a few examples where 56(2) might apply.

* Sale of an asset. If you sell an asset but direct the sale proceeds to be paid to your spouse or a family member with the hope that they'll pay the tax instead, 56(2) could apply to cause you to pay the tax anyway.

* Business income. Perhaps you own a business, provide goods and/or services to a customer, and then direct the customer to make payment to your spouse or family member and not you. Beware of 56(2).

* Rental income. If you own a rental property, or part thereof, and you instruct a tenant to make payment to your spouse, child, a charity, or some other party, subsection 56(2) could apply.

* Employment income. As an employee you could be subject to 56(2) if your employer makes a payment to one of your family members for services provided by you.

* Gifts by a corporation. Perhaps you're a shareholder and the corporation makes a gift of cash or property to one of your family members. Subsection 56(2) could apply to tax you on the value of the gift because the gift would likely have been taxable to you as a shareholder benefit had it been made to you.

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* Property sold to family. If you're a shareholder and your corporation sells an asset to a family member at an amount below fair market value subsection, 56(2) could apply.

* Dividends paid to shareholders. Consider a situation where dividends are paid to a shareholder who is not entitled to receive dividends and/or you had a pre-existing right to dividends. Or where you might waive your dividend entitlement for the purpose of transferring income to other shareholders. Subsection 56(2) could apply to tax you on those amounts.

Now you get the drift. Subsection 56(2) is not to be confused with the other attribution rules in our tax law that can cause investment income to be taxed in your hands when you give or lend investment assets to a family member. This provision is broader. It can even apply to tax you on payments made to unrelated third parties.

The solutions

You should note that there's often a way to accomplish the same tax savings without triggering 56(2).

This might mean receiving a payment yourself and then paying a deductible amount to a family member, properly transferring an asset to your spouse or child to allow them to pay tax on a sale later, restructuring your employment contract to allow payments to an assistant who might be a family member, or revising the terms of your company's share classes to allow a more flexible sprinkling of dividends, among other ideas.

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It's also worth noting that there's an exception for the splitting of CPP benefits, which is specifically allowed under our tax law.

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