Capitalization Under the Child Support Guidelines Means More Than Capital Assets

September 2026

When a parent earns income through a business, the money reported on a tax return is often not the money available to pay child or spousal support. The Guidelines recognize this. Where a parent earns income through a partnership or a sole proprietorship, the rules allow a deduction from income for any amount the business properly requires “for purposes of capitalization”.^{FCSG Schedule III, para. 12}

That short phrase carries a great deal of weight, and I believe it is frequently read too narrowly. Many of the calculations I review treat it as permitting an adjustment only for the purchase of capital assets, such as equipment, vehicles and buildings. I wish to explain why I think the phrase means considerably more than that, why the difference matters, and how the amount can be measured in a way that is fair to both parents.

Two Meanings of One Word

The word “capitalization” is doing double duty, and I wish to clarify the two senses, because the confusion begins there.

The first sense is the accounting one. When a business buys a piece of equipment and records it as an asset to be written off over its useful life rather than as an expense of the year, the cost is said to have been “capitalized”. This is the meaning most accountants reach for first, because it is the meaning used every day in preparing financial statements.

The second sense is the older and broader one. To capitalize a business is to supply it with the capital it needs in order to function. A business that cannot pay its suppliers, carry its inventory or wait for its customers to pay is said to be under-capitalized, and no amount of equipment will fix that. The money tied up in running a business from day to day is ordinarily called “working capital”.

A respected general dictionary carries both senses, which is itself instructive. Merriam-Webster defines the verb “capitalize” at sense 2b as “to treat as an amortizable investment in long-term capital assets rather than as an ordinary operating expense to be charged against revenue for the period in which it is incurred.” That is the narrow sense, and it is the one an accountant will find first. Three senses later, the same entry gives sense 4 simply as “to supply capital for.”^{Merriam-Webster.com Dictionary, s.v. “capitalize,” accessed September 17, 2026}

The noun matters more. “Capitalization” is defined as “the act or process of capitalizing,” without confining itself to any one sense of the verb, and separately as “the total liabilities of a business including both ownership capital and borrowed capital.” Note what that second definition covers. It is the whole funding of the business, equity and borrowings together, and not a category of accounting entry.^{Merriam-Webster.com Dictionary, s.v. “capitalization,” accessed September 17, 2026}

Note the wording of the paragraph itself. It does not say that a deduction is allowed for capital assets purchased, or for amounts capitalized during the year. It says the deduction is for an amount required “for purposes of capitalization”. Read plainly, that describes a purpose rather than a transaction. It is money the business needs in order to be capitalized, not merely money the business happened to spend on something recorded as an asset. Hence, when Schedule III speaks of an amount required for purposes of capitalization, there is no reason in ordinary English to read it as confined to the purchase of capital assets.

I am confident in this interpretation, and I should say plainly where my confidence comes from. I sat on the Advisory Committee on Child Support for the federal Deputy Minister of Justice from 1999 to 2001, and I obtained clarification of this paragraph from Justice Canada officials at that time. It is not published authority, and a reader who wishes to rely on it should treat it as my opinion supported by my reasoning, and not as something a court has decided.

Why the Broader Reading Is Necessary

Businesses report income on an “accrual” basis rather than a cash basis. Revenue is reported when it is billed, not when it is collected. Expenses are recorded when the purchase is made, not when it is paid. The cost of equipment, inventory and prepaid expenses is paid in cash but is not deducted at the time of purchase; it is allocated to the years in which those items are used, in the case of equipment through depreciation, which appears on a tax return as capital cost allowance.

The result is simple to state. Reported income and available cash are two different numbers, and they can differ by a great deal in either direction.

Take an illustration. A business reports pre-tax income of $200,000. During the same year, sales grew, so the amount owing from customers rose by $60,000 and inventory rose by $40,000 to support expected future sales. The owner also repaid $30,000 of loan principal, which is not an expense at all. Before one dollar is taken home, $130,000 of that reported income has already been absorbed by the business. Remember that growth costs money. A growing business needs more cash tied up in receivables and inventory than a mature one, which is the opposite of what most people expect.

None of those three amounts bought a capital asset. Confine the deduction to capital asset purchases, and none of them is recognized at all. The calculation would treat the full $200,000 as money the owner could have taken home.

Measuring the Need

Saying that a business needs cash is easy. Putting a defensible number on it is the hard part, and this is where I find most disagreement arises. The method I use starts from cash rather than from income, and it runs in four steps.

The first step is to determine what actually happened to the company’s cash during the year. This means preparing a statement of changes in cash from the balance sheets and the income statements and comparing the result to the business pre-tax income for the same year. Where cash flow sits well below pre-tax income year after year, the business is using cash for capitalization, and the pattern shows it.

The second step is the one that keeps the exercise balanced. Cash flow can often be borrowed. When capital assets are bought, long-term financing is usually available for a portion of the purchase price, and an owner who pays cash instead has made a business decision rather than encountered a necessity. Paying cash is frequently the wiser choice, because it avoids loan payments during a downturn. That does not clearly answer the question of what money is available for support. Consider the case where the business owner has always paid for capital assets without using loans because of a risk averse personality. While this may be appropriate to continue, particularly in a high-risk business, I feel it is important to reconsider this practice. There is now a new and important need to consider, being the support of the children. If a reasonable amount of financing is available without undue risk, then I believe this additional cash flow should be recognized as a source of funds even if it has not been used. I accept that there needs to be a balance between borrowing risk, normal business practice and the need for additional cash flow to meet personal support obligations. The estimate needs a basis, such as the proportion of the purchase price a lender would realistically have advanced on the type and condition of the assets involved, along with reasonable repayment terms, the owner’s own historical borrowing rates, industry standards for debt financing, the financial condition of the particular business, and the owner’s obligation for child support, both financial and moral.

The third step keeps the exercise honest, and requires a review of the three years of financial history that the Guidelines require to be disclosed, or more years if they are voluntarily provided. Have there been unusual changes in assets, liabilities, revenue and expenses since the relationship broke down? Is there a possibility of manipulation, or of business practices that may reduce the calculation of pre-tax income? Examples include early purchases of new vehicles and equipment, a reduction in financing for new purchases, a significant increase in inventory on hand, early payment of supplier invoices, prepaying expenses or making advance deposits, and other such items that affect the timing of cash flows. Deferral of a large sale may do the same. So may paying some personal expenses through the business, such as legal fees related to the separation. Explanations should be obtained for unusual fluctuations, which may very well be reasonable but should not be overlooked, particularly if the impact is not eliminated after looking at all three years.

The fourth step combines the above. Actual cash flow, plus the additional cash that available financing would have produced, adjusted for anything the third step uncovers, gives an adjusted cash flow. Where that adjusted figure is lower than pre-tax income, the difference is the amount the business genuinely required for capitalization, and that amount was not available to pay support.

Two cautions belong with any such calculation. It rests on estimates and assumptions, and neither the past nor the future can be recreated with precision. Establishing what credit a lender would have extended several years ago is particularly difficult, since hindsight is 20/20, and a young company with little history and thin collateral may have had no realistic access to borrowing at all. Other professionals may use different methods and reach different opinions.

A Line of Credit Does Not Remove the Need

It is sometimes argued that a business with an operating line of credit has no capitalization problem, because it can always draw on the line to cover a shortfall. I do not accept that.

A line of credit funds the wait between doing the work and being paid for it. Where customers take 60 days to pay while employees are paid weekly and suppliers within 30 days, the gap is real and recurring. The line covers it, but the line must then be repaid out of the very receivables it was advanced against, so nothing is released for the owner. A business already near its limit has no further room, and a bank will commonly refuse to count receivables as collateral once they pass 90 days, precisely when a slowdown makes the money most needed. The negative cash flow caused by selling on credit is a genuine capitalization need, even though temporary funding exists to carry it.

It Is Not an Exact Science

What a business genuinely requires is a matter of judgment. The need changes from year to year, varies by industry and moves with economic conditions. A manufacturer and a consulting practice have very different requirements, and a business in a downturn has different requirements again. One year in isolation can be misleading, which is among the reasons the Guidelines permit regard to be had to the last three years.^{FCSG s. 17}

The useful question is not whether the money was spent, but whether the money was required. If income must be reinvested in the business to sustain its operations, it is not available to the owner. If it was retained for some other reason, that is a different matter entirely.

Why This Matters to an Incorporated Business

Schedule III, paragraph 12 of the Guidelines, discussed above, applies only to partnerships and sole proprietorships. It does not apply to corporations, and I do not suggest otherwise.

It is, however, a useful analogy, and I have relied on it as one. Where a parent is a shareholder, director or officer of a corporation, and the income shown on the tax return does not fairly reflect all the money available for support, a court may include all or part of the pre-tax income of the corporation in that parent’s income. The Guidelines give little direction on how much. What the corporation genuinely requires in order to keep operating is plainly one of the considerations, and the reasoning does not change because the business happens to be incorporated.^{FCSG s. 18(1)}

While I am not a lawyer, my own reading of the court decisions suggests that the courts have said as much. In an early and frequently cited decision, the British Columbia Court of Appeal held that regard should be had to the nature of the company’s business and to any evidence of legitimate calls on its corporate income for the purposes of that business. More recently, the Nova Scotia Court of Appeal set out the considerations relevant to attributing corporate income and observed that one should not interfere with reasonable economic decisions needed to meet corporate sustainability.^{Kowalewich v. Kowalewich, 2001 BCCA 450; Ward v. Murphy, 2022 NSCA 20}

Two cautions belong with that. Neither decision uses the phrase “working capital”, so they support the broader reading without proving it. And the onus sits squarely on the parent who owns the business. A payor who says the money is not available must lead clear evidence to show it, and a bare assertion that the company needs its cash will not carry the point.^{Hausmann v. Klukas, 2009 BCCA 32; Teja v. Dhanda, 2009 BCCA 198}

There is also a floor. Where the adjusted cash flow is deeply negative, the arithmetic above will produce a reduction larger than the pre-tax income itself. That does not create a deduction from the parent’s personal income. The most a capitalization adjustment can do is reduce the corporate inclusion to nil. Where a corporation has an overall loss after the required adjustments, no pre-tax corporate income is available to attribute at all.^{Ward v. Murphy, 2022 NSCA 20 at para. 153}

I do not review the case law further here, and I leave that to legal counsel, as I am not a lawyer and am not offering legal advice. The concept produces the same type of calculation either way. A helpful overview of the principle and the related cases is set out in an article titled Determination of Income under S. 18 of the Federal Child Support Guidelines, prepared in June 2009 by Dinyar Marzban Q.C. and Jane M. Reid of Jenkins Marzban Logan LLP, Vancouver, for the Continuing Legal Education Society of British Columbia.

A Closing Thought

The point of all of this is fairness in both directions. A calculation that ignores what a business truly requires will overstate what a parent can afford to pay. A calculation that accepts every corporate expenditure as a necessity will understate it. Neither result is what the Guidelines intend.

If you are preparing or reviewing one of these calculations, you must investigate cash flow as well as income, look past the capital asset additions, ask what financing was realistically available and not used, ensure there has been no deliberate manipulation affecting the calculation of income, and look at several years rather than one. If you are a parent on either side of one of these calculations, ask your advisor to explain how the pre-tax business income was determined in your case.

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Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum