THIRD PARTY SUPPORT PAYMENTS
An earlier version of this article was published in Money & Family Law, Vol 11, No. 12, December 1996, page 95.
Spousal and child support payments made on a periodic basis are normally deductible to the payor. (Of course, this tax treatment of child support payments changed as of May 1997.) Lawyers may fall into a trap when it comes to structuring payments made by the payor directly to a third party.
For payments made to third parties to be tax deductible to the payor in a particular taxation year, lawyers should be careful and abide by the technical legal requirements:
- Put the obligation in a written agreement or court order.
- The order or separation agreement must specifically state that subsections 60.1 (2) and 56.1 (2) of the Income Tax Act are to apply.
- The third party payment must be for the maintenance of the former spouse.
- Specify the precise nature of the third party payment. (You do not have to specify the amount or the particular payee. You do have to adequately describe the payment.)
- The third party payment must be in respect of a maintenance expense that was incurred in the year of payment or in the preceding year.
- The parties must be living separate and apart when the expense was incurred and throughout the remainder of the year.
- Forget about including amounts paid in respect of a residence occupied by the payor at the time of payment. It does not matter that the parties are living separate and apart but under one roof. You cannot make the mortgage, property taxes, utilities, etc. tax deductible so long as the payor lives there.
- You cannot (with some exceptions) use the third party support payments to purchase tangible property.
In Lamb v. MNR (1994), 1 C.T.C. 2580, 96 D.T.C. 1336 (T.C.C.), the husband and the wife did live in two separate residences. Previously, the husband had been ordered to pay spousal and child support. The husband and wife then purported to modify, in writing, their divorce judgment so that instead of paying directly the monthly periodic support, the husband was to support the wife by directly paying the monthly rental payments, property taxes and home insurance premiums for the wife's home. There was no mention of the relevant provisions of the Income Tax Act.
The Minister disallowed the husband's deduction. On the husband's appeal to the Tax Court, it was held that "the amending agreement did deem these payments to be an amount paid by the Appellant and received by the former spouse as a benefit payable on a periodic basis." The court also found, somehow, that the wife retained "discretion as to the use of the maintenance payments". Yes. This was a victory for the taxpayer. But an appeal could have been avoided simply by including the magic words referring to the relevant sections of the Income Tax Act.
In Armstrong v. R.  2 C.T.C. 266, 96 D.T.C. 6315 (Fed. C.A.), the court order required the husband to make the mortgage payments and property taxes for the matrimonial home where the wife resided. The court order gave no discretion to the wife and did not include the magic words referring to the Income Tax Act. The taxpayer lost.
We have similar situations with different results.
Do not rely on the Lamb decision. When a judge is contemplating making an order that will obligate your client to make support payments to a third party or where you are negotiating a separation agreement with third party payments, review the legal requirements and make sure you include the correct wording. There are various precedents available to assist with this.
Payments, including third party payments that are not specified to be solely on account of spousal support, will be treated as being on account of child support. Such payments are not deductible under any circumstances.