GST and Real Estate

Transactions involving real estate seem to attract hectares of GST questions. Surprisingly, the basic rules are fairly straightforward. Unfortunately, there are many “out of the ordinary” situations that complicate matters. Happily, those will not be covered here. The rules discussed below deal with most transactions practitioners will ever encounter.

Before purchasing real estate, make sure to check the GST rules

What is Taxable?

Real estate transactions fall into two main categories: Supply by way of “lease or licence” (i.e., “rentals”), and supply by way of sale.

Generally, as is the case with all GST questions, the first rule is that every supply is taxable unless it qualifies for an exception. Thus, most commercial real estate transactions involving businesses will be taxable. The major GST exemptions will involve supplies of residential property.

The long-term rental of residential property is generally exempt.

A sale of property is exempt if it qualifies under the definition of “used residential” property. Generally, a residential property is considered used if it was previously occupied or intended for use by an individual as a personal residence.

New Residential Property

A sale of a new residential property is taxable. Generally, it is a “builder” who will make such a sale. Since the builder is himself carrying on a commercial activity, he will be claiming input

tax credits (“ITC”) on his construction costs, and then charging the GST when he sells the property.

The purchaser of a new home will be eligible for a “new housing rebate”. This rebate is equal to 36% of the GST paid up to purchases of $350,000. Between this amount and $450,000, the rebate is reduced, and is eliminated thereafter (for the QST, the dollar limits are $200,000 to $225,000).

Self Supply of Residential Property

If a builder, rather than selling a completed residential complex, decides to retain it as a rental property, the “self supply rules” will apply. He will be deemed to have sold himself the property. He will self-assess and remit GST based on the fair market value of the property, including the land. This tax is not eligible for an ITC, since it is an acquisition of a residential property. It will, however, qualify for the residential rebate. If the complex is an apartment building with many units, its value will likely exceed the $450,000 limit. However, these limits will apply to each unit based on its square footage. Accordingly, if a builder completes a 5 unit apartment whose value is $1 million, each unit might be valued at $200,000 and will qualify for the full rebate.

These self-supply rules will apply equally to a “substantial renovation” of a residential property.

Input Tax Credits

Generally, any GST registrant carrying on a commercial activity is entitled to an ITC for expenses. If the activity of the purchaser is part commercial and part exempt or personal, then the ITC must be apportioned in a reasonable manner.

For capital property other than real estate, if the property is used more than 50% in commercial activities, it will be eligible for a full ITC.

A purchase of real property is subject to unique rules. Generally, the ITC must be apportioned based on commercial use. If the purchaser is an individual, no ITC is available at all if the property is used primarily (>50%) as a residence. Thus, an accountant who uses 20% of her home as an office cannot claim any ITC on the real estate purchase.

Who Collects

Generally, a vendor of real property is responsible for collection and remittance of the GST. However, this is not the case where the purchaser is a GST registrant. In this case, the purchaser will self-assess the GST and simultaneously claim any eligible ITC. The vendor should verify the purchaser’s registration number with the government.

If the sale of real property is exempt, it will be because of the vendor’s history with the property. The purchaser should insist on a written confirmation of exempt status from the vendor. Otherwise he will be liable for the tax if such status is subsequently denied for any reason.

Published in:  on February 3, 2010 at 4:10 pm Leave a Comment
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Selling Low

I am often asked during the course of a year whether a taxpayer, for whatever reason, can make a sale of property at a price lower than fair market value, transfer an asset for no consideration, make a gift to a relative or friend, either personally or through a corporation, etc. You get the idea.

The Income Tax Act (“the Act”), being the complex animal that it is, contains many provisions that deal with these questions, and, depending upon the circumstances, any one or more of them could apply. And we won’t even get into the General Anti-Avoidance Rule. What follows is a general discussion of some of these provisions.

Subsection 69(1) – Inadequate consideration

Subsection 69(1) of the Act provides rules that apply where any consideration other than fair market value is provided in any transaction between people who are not dealing at arm’s length. Generally, the provision provides a one-sided adjustment to the selling price. If the proceeds are too high, then the purchaser’s cost amount will be adjusted downwards. If the price is too low, then the seller’s proceeds will be adjusted upwards. If there are no proceeds at all (i.e., a gift) then the transfer will be deemed to have been made at fair market value for both parties.

Subsection 15(1) – Shareholder Benefits

Subsection 15(1) of the Act is a broad provision that taxes shareholders (and future shareholders) on the value of any benefit conferred on them by a corporation. This subsection would cover such transactions as the issuance of treasury stock at less than fair market value, and the forgiveness of shareholder debt.

Some exceptions apply, such as stock dividends, and treasury shares where identical offers are made to all existing shareholders.

Subsection 56(2) – Indirect payments

Subsection 56(2) of the Act applies to “indirect payments”. It deals with situations where a benefit is conferred on a person, where that benefit would, if it were paid to the taxpayer, be taxed in the taxpayer’s hands. The effect of the provision is to tax the person who confers the benefit.

According to the CRA, there are four conditions that must be met for this provision to apply:

(a) there is a payment or transfer of property to a person other than the taxpayer;
(b) the payment or transfer is pursuant to the direction of, or with the concurrence of, the taxpayer;
(c) there is a benefit to the taxpayer or a benefit the taxpayer wishes to confer on the other person;
(d) the taxpayer would have been taxable on the amount under some other section of the Act if the payment or transfer had been made directly to the taxpayer.

A simple example is where a director of a corporation makes a payment to a person who is a non-shareholder of the corporation at the request of a shareholder.

It has been held that subsection 56(2) cannot be applied to dividends paid to one shareholder to exclusion of another at the discretion of the directors of a corporation (i.e., discretionary dividends).

Subsection 246(1) – Benefit Conferred On A Person

Subsection 246(1) of the Act is another broad rule that provides that where a person confers a benefit on a taxpayer, the amount of the benefit must be included in income of the taxpayer.

Subsection 246(2), however, provides an “arm’s length” exception, where all of the following four conditions are met:

(a) The person and the taxpayer are dealing at arm’s length;
(b) The transaction is bona fide;
(c) The transaction is not pursuant to, or part of any other transaction; and
(d) The transaction was not entered into to effect payment of an obligation.

There is very little jurisprudence with respect to the saving provision in subsection 246(2). The only case involving this provision is Pelletier et al v. the Queen. In that case, a shareholder sold his shares to the other arm’s length shareholders of the same corporation for less than fair market value. The exception was held to apply.

Generally, the CRA likes transactions to occur at market value. Any deviation could invoke any one of the above provisions, so as always, be cautious.

Published in:  on January 22, 2010 at 10:57 pm Leave a Comment
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Rollover of RRSP’s and RRIF’s on Death – Don’t Take It For Granted

If you are the executor of an estate, or you are perhaps advising your client on his will, you should be aware of the rules regarding RRSP’s and RRIF’s on death.

I’m surprised at the number of people, executors and plan administrators alike, who work on the often erroneous assumption that these plans simply roll over tax-free when the surviving spouse is named as the beneficiary.

In fact, the opposite is true. While capital property automatically rolls over tax-free to a spouse on death, a RRSP/RRIF does not. The general rule is that it is taxable in the hands of the deceased annuitant. From there, a number of possibilities can occur.

If the spouse is named as the “successor annuitant”, then the capital in the plan is not paid out. The plan simply continues and the spouse replaces the deceased as the annuitant. There is no tax to the estate and no reporting is required. The successor annuitant can be named in the plan itself or in the will. The successor annuitant can also be established in other cases if the executor and the plan administrator agree.

If there is no successor annuitant, then the proceeds of the plan are realized and they are taxed either in the hands of the surviving spouse or the estate, depending on the circumstances. If the spouse is designated as the plan beneficiary in the contract, the payment of funds is made to the spouse upon death of the annuitant, and the spouse adds the amount to income. The spouse then has until 60 days after the end of the year to transfer the funds to his or her own RRSP/RRIF to obtain an offsetting deduction.

If the spouse is named as a beneficiary in the will alone (which will likely be the case in Quebec), then the payment of funds is made to the estate. The executor and the spouse must then agree and file an election (form T2019 for RRSP’s  or T1090 for RRIF’s) to have the proceeds added to the spouse’s income, and be eligible for rollover into his or her plan.

What if the spouse refuses to sign the election?

Take the case where a deceased man is survived by his second wife, has children from a former marriage and the leaves a RRIF to the spouse in the will, with no clear instructions regarding the taxes. The residue from the estate goes to the children. The executor must receive the funds from the RRIF and pay them to the spouse under the terms of the will. No taxes are deducted from this amount. The spouse can then choose not to make the election. She will receive the entire amount of untaxed capital from the RRIF and she will not have to roll it into her own plan, thus avoiding future taxes on withdrawal. The taxes will be borne by the deceased, and be taken from the residue of the estate, thus providing a possible unintended benefit to the spouse, and most likely some very disgruntled children.

Published in:  on January 12, 2010 at 11:14 am Leave a Comment
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Wright is Wrong….Again!!!

Once again, I am personally forced to swallow a tough court decision, as the case of Pechet v. The Queen (2009 DTC 5189) has been dismissed by the Federal Court of Appeal. This case overturned the informal procedure Tax Court decision of Wright v. The Queen (2001 DTC 437) originally argued  (and won) by yours truly.

The Wright case dealt with interest on unpaid non-resident withholding taxes. Under Part XIII of the Act, anyone paying rent to a non-resident must withhold tax based on the gross amount paid. The rate is 25% unless reduced by treaty. The basis for withholding may be reduced to the net amount after expenses if an undertaking is filed with the CRA and form NR6 is filed. (For more, see my post on Non-resident Real Estate Investors)

If the non-resident recipient files an income tax return under section 216 of the Act by the required deadline, tax under Part I of the Act is applied “in lieu of” the Part XIII tax withheld. In essence, any tax withheld in excess of the Part I liability is refunded.

Where the Part XIII tax is not withheld, but the section 216 is filed, the CRA’s position is to charge interest based on the withholding tax that should have been remitted. The original argument in Wright was that if the filing of the 216 return replaces the Part XIII liability with the Part I liability, then there is no longer any tax upon which an interest calculation may be made. The Tax Court agreed, and a loophole seemed to be exposed.

The Pechet case heard in Tax Court overturned Wright, but there was still a glimmer of hope as it was appealed to the Federal Court of Appeal.

Now, sadly, it appears my own personally victory remains just that. Since decisions in  the informal procedure cannot be appealed, my client’s victory is final and my Tax Court record is still 3-0. However, my legacy as a precedent-setting barrister is over for good.

The Court of Appeal in Pechet upheld the decision of the lower court and concluded that the filing of a return under section 216 of the Act does not retroactively eliminate the requirement to withhold under Part XIII. Rather, the withholding requirements continue to apply, up until the point in time when the tax liability of the non-resident has shifted from Part XIII to Part I. The phrase “in lieu of” does not mean that the Part XIII liability never existed, but that it is replaced, at the time of the filing of the return, with the Part I tax liability. Any interest accruing on unpaid withholding tax up to that point must be paid.

This interpretation, in all fairness, seems to be the correct application of the provisions, given the scheme and intent of the Income Tax Act as it applies to non-resident taxpayers.

Published in:  on January 5, 2010 at 4:04 pm Leave a Comment
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Merry Christmas Everybody!!

If you haven’t seen this yet, you can thank me later.

Enjoy!!

Published in:  on December 23, 2009 at 6:47 pm Leave a Comment

More Than Five Means…..?

The phrase “more than five full time employees” is used in the Income Tax Act (“the Act”) mainly to establish whether an investment business is to be considered “active” for the purposes of the definitions of FAPI (foreign accrual property income) and, more commonly, for the purposes of claiming the small business deduction.

Until recently, the 1994 case of The Queen vs. Hughes & Co. Holdings Ltd. was the guiding precedent. In that case, the Tax Court interpreted the phrase to mean that all the employees considered must be full time, and there must be more than five, meaning at least six of them.

Enter the new millennium, and the interpretation has changed. In the recent case of 489599 B.C. Ltd. vs. The Queen, the Court has overturned the Hughes interpretation of the phrase, conceding that five full time employees plus one part time employee will satisfy the requirement. It all comes down to grammar, of course. The Court concluded that the word “more” modifies “than five”, and not, as Hughes suggested “full-time employees” (just play with the emphasis on different words and you’ll get the idea).

The Court goes on, however, to confirm the other principles set out in Hughes. There still must be five employees that are full time. You cannot, for example add up ten part-timers to meet the test. Nor can you allocate fractions of employees among co-owners or partners in a partnership. Each business must count its employees on its own.

At the recent Canadian Tax Foundation Conference, the CRA confirmed that it will abide by the more recent decision.

Published in:  on at 5:02 pm Leave a Comment
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What’s Your Tax Issue?: Returning To Canada

The Tax Issue:

My first question to anyone who wants to move to Canada from the Bahamas: WHY?

My wife and I have been expats for 12 years.  We would like to know if we come back to Canada can we keep our Bahamas IBC corporation that holds all our stock and bonds and pays us a yearly income? We presently only spend about 50% of our income, which is of course tax-free.

Or if we return to Canada, do we have to close the IBC and hold our investments personally,(or even keep the IBC) and still declare and pay taxes on all our annual income?

The Answer:

Well, it’s good that you only spend about 50% of your income, because, you may have to start paying just about that amount to Revenue Canada. From the time that you return to Canada, you will be subject to Canadian income tax on your world income.

There is no requirement to close your IBC when you return to Canada, but it may not be such a bad idea.

If you maintain your ownership of shares in your IBC as a Canadian resident, you will be subject to tax personally on all the income earned by the IBC, regardless of whether it is paid to you or not. This is known as “Foreign Accrual Property Income”, or “FAPI”. FAPI is what prevents a Canadian taxpayer from sheltering investment income through an offshore company.

On the other hand, if you wind up your IBC before entering Canada, all your investments may benefit from a “step-up” in cost, meaning that, for future capital gains purposes, the tax cost of each investment will be equal to its value at the time you enter Canada.

The annual income from your investments will be taxable to you either way as its earned, but holding them personally as a Canadian resident will likely be much simpler and less costly in the long run.

Before doing anything drastic, though, I would strongly recommend that you review your particular situation with a tax advisor.

Published in:  on December 21, 2009 at 6:06 pm Leave a Comment
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Quebec Business Corporations Act

I just got back from a seminar on the new Quebec Business Corporations Act (“QBCA”). These proposals will replace the current Quebec Companies Act in its entirety. When the new law is enacted (probably within 1 year) all companies currently incorporated under Part 1A of the current law will automatically become QBCA corporations.

The new act incorporates all the best features of the CBCA and other provincial statutes, billing itself as the most modern of Canada’s corporations acts.

The term “company” will no longer apply to Quebec charters; they will now be known as “corporations”.

Some of the features of this new act that are most interesting to me as a tax practitioner are:

Incorporation: The incorporation process will be much easier. Online incorporation will be available, and no name search report will be required.

Ability to issue par value shares: OK, this one already exists in the current law, but it will continue in the QBCA, which remains an advantage over the CBCA. This facilitates the use of “high/low” stock dividends in corporate reorganizations.

Ability to issue different classes of identical shares: The CBCA currently allows this, although few people are aware of it. This feature will facilitate the payment of discretionary dividends.

Corporate incest allowed: The QBCA will allow shares of a parent company to be held by its subsidiary for a period of 30 days. This will be a big help to those of us doing corporate spinoffs and other internal reorganizations.

Fractional shares permitted: Very often, when performing a reorganization, shares are split up into fractions. The old law did not allow such shares to exist. Now it will, but not upon an issue from treasury.

Amalgamations: Short-form amalgamations will be much easier, and will include sister companies where the shares are owned by an individual.

Dissolutions: There will be a much more streamlined method for dissolution, including the elimination of the need to put an ad in the newspaper.

Directors: There will be no requirement for directors to resident in Canada.

That’s just a small sampling of the more interesting features of the coming law. Of course, the list is by no means exhaustive. If you are truly interested in this topic, you can  read the entire text of Bill 63, either in English or in French.

Published in:  on December 17, 2009 at 2:51 pm Leave a Comment
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CRA Exposes More Offshore Shenanigans

If you’ve been following the UBS scare in the U.S. (see my previous post on this topic) please add the tiny state of Liechtenstein and the relatively large Canadian  institution known as RBC Dominion Securities to the list of names associated with offshore shenanigans.

The CBC reports that the Canada Revenue Agency is investigating 13 taxpayers who set up offshore accounts with LGT Group in Liechtenstein. These accounts were set up with the aid of Colin Ross, a former investment adviser at the Victoria branch of RBC.

Liechtenstein: Small, beautiful, and one of the tax community's best kept secrets

The CRA’s investigation, launched last year, found that certain foundations were set up and used by taxpayers to “masquerade as non-residents.” The agency says the taxpayers were “hiding their investments and other income” and “evading their obligation to pay Canadian tax.”

Of the 13 taxpayers implicated, some have made voluntary disclosures, and will therefore likely escape criminal charges and penalties. Others are under the gun for tax evasion, including  one Victoria woman who told investigators she felt having an offshore account was “glamorous”.

RBC  has released a statement disavowing any wrongdoing as a firm. The CRA is now investigating whether more Canadians are doing the same thing through RBC advisers across the country. But it won’t stop there. Revenue Minister Jean-Pierre Blackburn is quoted as saying “We will go after every other bank to obtain the list of their clients who do business abroad and to see if those clients declare their income.”

Published in:  on December 14, 2009 at 1:50 pm Leave a Comment
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Put On Your Yamakah!

No tax issues today.

I’d like to take this opportunity to wish everyone a happy Chanukah  and  in that spirit let’s all share in one of the well-known rituals of this festive holiday. It’s a traditional Chanukah song, but with a bit of a twist. That’s right, it’s the excellent rockin’ cover of Adam Sandler’s Chanuka song by the fabulous (and Jewish) Neil Diamond.

Enjoy! And have a happy happy Chanukah!

Published in:  on December 13, 2009 at 12:36 am Leave a Comment
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