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Muth Estate: Executor Sought and Denied Indemnity from Beneficiaries for Income Tax Liability of Estate

In this recent Alberta Court of Queen’s Bench case, Muth Estate, 2019 ABQB 922, the executor was found to be personally responsible for paying a significant portion of the estate’s tax liability after relying on an incorrect hold-back estimate by an accountant when she distributed the estate assets to the beneficiaries.

Background

The estate in question was the executor’s husband’s estate. He had died in 2008 and a dispute arose over his estate. Rather than continue with litigation and a trial, the parties, one of whom was the executor, reached a mediated settlement in 2011. Pursuant to the settlement, the executor would apply for probate and the estate was to be divided 55% to the executor and 45% to the other beneficiaries (nieces and nephews of the deceased).

The executor retained an accountant in 2011 to prepare the final income tax return for the estate and to estimate its tax liability. The accountant advised that a $25,000 holdback would be sufficient. The executor then distributed the balance of the estate in the proportions agreed to in the mediated settlement.

The first accountant did not file the return. So, a second accountant was hired, who determined that the holdback was not sufficient as the tax liabilities would be close to $60,000. The executor personally paid the difference to the Canada Revenue Agency (together with the accountant’s invoice) and sought repayment of 45% of those amounts from the other beneficiaries. They refused. The executor commenced a claim.

The Court Decision

Justice Little was asked to decide whether the executor was entitled to be indemnified by the beneficiaries.  He noted that the negotiated settlement did not specifically deal with an indemnity. It only dealt with the costs of the mediation and legal fees and also that “probate and administration costs were to be paid form the estate ‘in the usual course’”.[1]

The executor argued that the word “net” should be read into the settlement agreement, which meant that the 45% to the beneficiaries meant “net of taxes” and therefore the beneficiaries should pay their percentage of the taxes due. Failing which they would receive more than their entitlement. Justice Little did not accept this argument:

“Net of taxes” would more logically mean that the estate looks after the taxes. If not, and some beneficiaries pay tax and others do not, or if they are in different tax brackets, then some beneficiaries benefit more than others and therefore receive a higher percentage.[2]

The beneficiaries relied on Section 159 of the Income Tax Act for their position that only the executor is liable for unpaid taxes. Section 159 requires that a personal representative obtain a clearance certificate before distribution of an estate and imposes personal liability for the tax liability of the estate on those who do not do so. Justice Little found some support for the beneficiaries’ case in section 159, but “did not find it determinative” of the issue, as:

Parliament was concerned with imposing a duty on executors to ensure the payment of tax and a consequence for not doing so but did not take the next step of allocating responsibility among beneficiaries for an executor’s breach of that duty.[3]

Justice Little also noted that the Alberta estate administration legislation did not deal with the indemnity of an executor by a beneficiary.

Next, under an analysis of trust principles and breach of trust, Justice Little noted the question here was whether, if it is the trustee seeking relief as opposed to a beneficiary, would such a trustee be entitled to indemnity from the beneficiaries? In equity, such an indemnity was only available when the beneficiaries instigated or requested the breach of trust.[4] This was now codified in Alberta’s The Trustee Act RSA 2000, c T-8 at section 26.

The natural corollary of that principle, noted Justice Little, was that:

if the beneficiaries did not instigate or request the breach, they cannot be obligated to indemnify the trustee.  In a fiduciary relationship such as that between a trustee and a beneficiary, the logic of that corollary is that as between the two parties, one who had the obligation to perform a duty and failed and one who had neither the obligation nor the means to satisfy it, it is the former who should bear the consequences of the action or inaction.[5]

Therefore, the executor undertook certain responsibilities (in accordance with the terms of the settlement) that overlaid the purely contractual agreement relationship with a trust relationship, with its consequent change in the respective rights and obligations of the parties.

Justice Little concluded that the beneficiaries were under no obligation to indemnify the executor for any income tax or penalties imposed on the executor as a result of her failure to obtain a clearance certificate before distributing the estate.[6]

Conclusion

In this case the buck stopped with the executor. This is an important reminder to anyone acting as an executor (or estate trustee as they are called in Ontario) that they can be held personally liable for the deceased’s unpaid personal or estate taxes. It is critical to obtain professional advice and a clearance certificate from the CRA before making any distributions to the beneficiaries.

[1] Muth Estate, 2019 ABQB 922 at para 43.

[2] Muth Estate, 2019 ABQB 922 at para 44.

[3] Muth Estate, 2019 ABQB 922 at para 55.

[4] Muth Estate, 2019 ABQB 922 at para 62.

[5] Muth Estate, 2019 ABQB 922 at para 63.

[6] Muth Estate, 2019 ABQB 922 at para 65.

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