Unreasonable Deductions of Business Expenses Can Improperly Reduce Child Support

Point of sale device representing unreasonable deductions of business expenses can improperly reduce child support

Written on behalf of Shariff & Associates

Determining a party’s income is key when establishing child and spousal support. However, individuals who are self-employed or run a business can face extra scrutiny. This is because the party has greater control over their income and may deduct business expenses that have been incurred to earn income. In some cases, the party may be able to manipulate their financial affairs, reduce their income, and benefit by declaring personal spending as business expenses. This can decrease the party’s income with the result that they pay less support.

Reasonableness of Deduction Not Determined by Income Tax Act

A party claiming a business expense is being unreasonably deducted from income has the burden of establishing that the expenses are unreasonable. However, in Szitas v. Szitas, the court explained that payors who deduce expenses from their income are obligated to explain the reason for the expense and how they were calculated. Receipts for significant expenses will also be helpful in assessing the reasonableness of expenses.

Addressing Unreasonable Expense Deductions

Section 19 of the Child Support Guidelines enables courts to impute an amount of income to a parent or spouse that it considers appropriate in the circumstances. Subsection 19(1)(g) concerns unreasonable deductions of expenses from income. To impute expenses that have been deducted against income back into a parent’s income, courts have found that it is not necessary to establish the party claiming the deduction “acted improperly or outside the norm for claiming expenses in the income tax context”. In fact, section 19(2) specifically states that “the reasonableness of an expense deduction is not solely governed by whether the deduction is permitted under the Income Tax Act”. Instead, as Justice Chappel explained in Templeton v. Nuttall, “the issue is whether the full deduction of the expense results in a fair representation of the actual disposable income that should be available to the party for personal expenses and child support”.

Parties who operate a business have discretion about business spending which can impact the amount of income that is available for financial support. In Osmar v. Osmar, the court explained that the Guidelines require balancing business necessity against using funds for child support. While “the court should respect the right of self employed persons to run their business as they see fit, but may, nevertheless, question whether particular expenditures ought to be indirectly subsidized by lower child support”. Further, support payors cannot “be permitted to manipulate their financial affairs so as to prefer their own interests over those of their children”.

Courts Look at Whether Personal Expenses are Deducted as Business Expenses

In Leal v. Leal, the court had to determine the amount of income that should be imputed for the purpose of deciding child support. The father was the owner of a business, and he argued that since separation, his income, which he paid himself from his business, remained between $55,000 and $65,000, while the mother’s income increased by over $30,000 to more than $100,000. On that basis, the father sought retroactive child support and an increase in child support going forward.

On the other hand, the mother claimed that the father used his business for personal expenses and deliberately underpaid himself in an effort to keep his income low and minimize his support obligations. She suggested his income should be imputed to $135,000. At this level, the father would owe her child support payments. The father’s only source of income was from his business, in which he was the sole shareholder. Although the company’s revenues had increased, he claimed that net income had not.

Father Admits His Business Pays Some of His Expenses

The father admitted that his business did pay some expenses, such as the truck, cell phone, and home office expenses, but noted that his business bank account was not used for his personal expenses. The father retained an expert who conducted a net worth analysis, which concluded the father’s reported income was a “fair representation of his income”.

The mother suggested that the father’s use of his business for personal expenses meant the expenses should be attributed to his income. She also retained an expert to critique the father’s analysis, and this expert was of the opinion that the father’s income was higher than $65,000. The court agreed that additional income should be imputed to the father as there were several shortcomings in the father’s net worth analysis. The father’s expert relied solely on the father’s reporting of assets without searching other public records to assess his true net worth. Further, the expert did not ascertain if the father’s reporting of business expenses was “accurately limited to business expenses or if there are other payments made” for the father’s personal benefit.

Courts Can Fix Income at a Level That Reflects the Money Available for Support

Looking at some of the company’s purchases, it was notable that a new truck was purchased in 2017, another in 2018, and a third was bought in 2021. The mother’s expert and the judge questioned whether the truck purchases were necessary, as some of those funds could have been paid to the father as income which would have assisted with child support.

The reasonableness of some company equipment expenses were not addressed in the father’s analysis. The mother’s expert proposed adding 50% of these vehicle expenses to the father’s income. Overall, the failure “to analyze the father’s personal expenses under the Guidelines has the effect of underestimating the full value to the father of the benefit from these personal expenses”. The mother identified a number of personal expenses that were not accounted for in the company’s general ledger, and since the father did not have receipts for the company’s questionable expenses, it was noted that “the company had an unusually high number of purchases for a company that only supplies labour”.

Adverse Inference Can be Drawn Against Payors Who Fail to Provide Receipts to Substantiate Income

In Lafazanidis v. Lafazanidi, the court explained that an adverse inference can be drawn against payors who fail to provide receipts to substantiate income and expenses, an approach which was employed by the court in this case. The father could not explain why he only paid himself $60,000 a year when company revenues increased, and why, as the business owner having management responsibilities, he paid himself the same salary as his employees.

Although self-employed individuals can rely on their business for personal expenses, the court warned that “the business is not used to shield personal income so as to undermine child support obligations”. The mother provided enough evidence to warrant imputing additional income to him as the father did have personal expenses and unreported income that was not accounted for in the company’s general ledger.

Key Takeaways: Parties Cannot Manipulate Their Income to Reduce Support Payments

Even though deductions may be legitimate for tax purposes, it may not be an accurate representation of a party’s income. Support payors might try to report a lower income to avoid support payments. Importantly, courts can adjust income to better reflect the earnings a party has available for support purposes. When evaluating business deductions, parties can consider how the claimed expenses relate to the business activities.

Contact the Family Lawyers at Shariff & Associates for Advice on Child Support Disputes

The skilled separation and divorce lawyers at Shariff & Associates work with clients throughout Markham Stouffville and surrounding areas to identify fair and equitable resolutions to child support disputes through various means, including negotiation, collaborative family law and litigation when necessary. To discuss your child or spousal support matter with a member of our team, please reach out to us online or call us at 905-591-4545.