Tax Court Agrees that Payments Recorded as “Salary” Were Actually Shareholder Loans

Tax Court Agrees that Payments Recorded as “Salary” Were Actually Shareholder Loans

The Tax Court of Canada’s recent decision in Malamute Contracting v the Queen (“Malamute”)[1] illustrates the problems that casual notations in financial records can create; namely, that the Canada Revenue Agency (the “CRA”) can cherry-pick those notations to develop an assessing position against compliant taxpayers.

The Facts

The taxpayer in Malamute was “a small contracting company engaged primarily in kitchen and bathroom renovations”. The shareholders of the taxpayer were the married couple David and Danielle Lynch. David did most of the hands-on work with the support of two employees, while Danielle maintained the business’ books.[2]

Malamute issued biweekly cheques to the Lynches between January 2018 and March 2019 for “generally consistent” amounts. The cheques had the notation “payroll” on the “re:” line, and generally consisted of “uneven amounts” (such as $1,889.12) that suggested that they were “amounts that one would get after deducting income-tax and Canada-Pension-Plan (“CPP”) withholdings from an even gross salary number.”[3] Malamute actually made income tax and CPP remittances on the cheques issued in January and February 2018, but then ceased doing so and instead started treating the payments as shareholder advances.[4]

The CRA took the position that the payments made on or after March 2018 were also salary on which Malamute needed to withhold and remit income tax and CPP. The CRA assessed Malamute accordingly, including for penalties.[5]

As was explained at trial, and accepted by the Court, it was ultimately Danielle’s “enthusiasm to comply with tax obligations that created Malamute’s problem”.[6] Danielle had no prior experience as a bookkeeper. However, she knew that she and her husband would have to ultimately pay tax on amounts they received from Malamute, and thus used a government website to try to estimate how much tax would be owing in respect of each cheque. This resulted in the cheques being issued for the “uneven” amounts, as well as the mistaken remittances in January and February 2018.[7]

Malamute’s situation exemplifies the adage that “No good deed goes unpunished”.

The Decision

Justice Cook, speaking on behalf of the Tax Court, noted that it was settled law that “[t]he tax treatment of a payment is governed by its character at the time the payment is made”, such that once a payment is made as salary, it cannot retroactively become something else for tax purposes.[8] On the other hand, Justice Cook noted that “a taxpayer may make entries in its books of account to reflect adjustments to its accounts as and when they take place”, and that “a shareholder-employee might draw money as loans from a corporation throughout the year. Then at the end of the year, the shareholder-employee’s mix of dividends and salary for the year is decided. The loan account is adjusted accordingly.”[9]

Justice Cook held that, based on the testimony of the Lynches as well as their accountant, “the plan all along was to pay the Lynches by way of dividends and not salary” given that “[p]aying salary could create massive cash flow problems for a small business like Malamute if cash was not available for remittances.”[10] He noted as well that Malamute’s financial statements were consistent with the Lynches’ not having received employment remuneration, and that the cheques “were generally accounted for as draws against the shareholder loan account”.[11] He criticized the CRA for essentially cherry-picking what occurred in January and February 2018 and ignoring the entire year that followed, noting that “[t]his strikes me as an unwarranted extrapolation by the CRA that did not adequately consider the factual context.”[12]

The CRA attempted to argue that Malamute lacked the solvency to declare and pay dividends, such that amounts paid to the Lynches had to be salary. Justice Cook rejected this argument, noting that “even if Malamute had solvency issues, I do not see how that could turn the Cheques into salary if they were not otherwise so characterized”.[13]

The CRA also attempted to argue that Malamute “admitted” that the cheques were for salary, since, during the CRA’s audit, their accountant suggested that the cheques in January and February 2018 (on which remittances were made) might be considered salary, but not the rest. Justice Cook declined to give effect to this statement, noting “[t]his does not strike me as an admission by Mr. Pallard so much as a concession by him to try to settle the file with the CRA.”[14]

Observations

It is understandable why the CRA chose to audit Malamute, given that the company abruptly ceased making remittances on its biweekly payments to its shareholders. However, it is less understandable why the CRA chose to assess Malamute—including for penalties—and then to litigate the matter to verdict in light of all other documentary evidence, as well as the explanations of the Lynches, that supported the conclusion that the remittances in January and February 2018 were made in error and the “salary” notations on the cheques were not dispositive. As noted by Justice Cook, there was nothing unusual or objectionable from a fiscal perspective about the Lynches’ taking draws from Malamute throughout the year as shareholder advances, and then determining their mix of dividends and salary at year’s end. Simply put, while the Lynches made some errors in Malamute’s bookkeeping, they were, in the end, compliant taxpayers managing their affairs in a manner consistent with other owner-managed small businesses.

Ultimately, the case offers an unfortunate illustration of how the CRA  can:

1. cherry-pick facts to support a tenuous assessing position, while disregarding facts that point the other way;
2. take annotations in a taxpayer’s books and records as dispositive when doing so can support an otherwise tenuous assessing position; and
3. regard good faith efforts by taxpayers to bridge the gap with the CRA as “admissions” of their tax liability.

The case offers an important reminder to owner-managers of the need for careful bookkeeping and to take particular care with respect to recording and describing payments to owner-managers, as well as the value of obtaining professional assistance with respect to ensuring fiscal compliance.

[1] Malamute Contracting v the Queen, 2025 TCC 47.
[2] ibid ¶2-3.
[3] ibid ¶4.
[4] ibid ¶11.
[5] ibid ¶5-6.
[6] ibid ¶17.
[7] ibid ¶15-17.
[8] ibid ¶7, 9, 10.
[9] ibid ¶8.
[10] ibid ¶14.
[11] ibid ¶17-18.
[12] ibid ¶24.
[13] ibid ¶19.
[14] ibid ¶22.

by Michael H. Lubetsky

A Cautionary Note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2025