What’s Your Tax Issue? Home Built By Company

The Tax Issue

I recently built our “dream” home for 2.50M$. However, not having sufficient funds personally, my professional corporation financed the construction of the house for me, writes off the maintenance, utilities and taxes, and I rent the house from my company at a market value rent, having researched comparable rents in the neighbourhood. Apart from forgoing the principal residence exemption – are there any other detriments to this strategy?

The Answer

Could be. I’m assuming, since you are paying rent, that you’re aware of the shareholder benefit rules. That is, by virtue of the fact that the company has financed your house and pays expenses on your behalf, you are exposed to tax on the value of the benefit you are receiving from the company.

What you may not be aware of is how the CRA might establish the value of the benefit. It could be the market value rent as you have researched, and if so, the rent you’re paying would be enough to offset the taxable amount completely.

In your case, however, it may not be so simple. There is a line of jurisprudence, starting with the case of Youngman v. The Queen, that suggests that the benefit or advantage conferred on you is not merely the right to use or occupy a house; it is the right to use or occupy a house that the company, at your request, had built specially for you in accordance with your specifications. How much would you have had to pay for the same advantage if you had not been a shareholder of the company?

So what is this “alternative” calculation? Generally, the value of the benefit could be calculated by reference to the income the corporation would have earned if its capital had been productively employed and not based on the fair market rental value (which might be considerably lower).

As an example, on a $2.5M capital outlay, the company could have been expected to earn interest in a relatively risk-free investment of, say anywhere from 2% to 5%. This would mean an annual rent of $50,000 to $125,000, plus expenses. If you are paying any less than this in rent, despite what the market rents are in the area, then you could be exposed to a greater taxable benefit than you thought.

Life insurance and Shareholder Benefits

Corporate-owned life insurance is always a hot topic. Generally, a corporation will be the owner and beneficiary of a policy. The proceeds received on death are tax-free to the corporation. However, a whole life policy is also an investment vehicle which has an adjusted cost base (“ACB”) for tax purposes. Only the excess of the proceeds over the ACB of the policy can be distributed to the shareholders on a tax-free basis via the Capital Dividend Account (“CDA”). For this reason, it is often recommended that the beneficiary be separated from the corporate owner so that the full amount of the proceeds can be received tax-free.

If the beneficiary is different from the corporate owner, questions arise as to whether a benefit is being conferred by the corporation. If the beneficiary is an individual shareholder, the CRA has stated that a taxable benefit will arise.

During the 2009 Canadian Tax Foundation Conference, the CRA announced a change in its policy regarding the holding of life insurance by a corporation with a holding company as the beneficiary.

The CRA was asked for its view on the application of subsection 15(1) (shareholder benefit) in the following situation: A, an individual, wholly owns Parentco, which in turn wholly owns Subco. Subco has a life insurance policy on the life of A and pays the policy premiums. The beneficiary of the policy is Parentco. This strategy is often useful because the full amount of the insurance proceeds in this structure gets added to the CDA account of Parentco and is not reduced by the policy’s ACB.

In previous policy statements, the CRA stated that the shareholder benefit provisions would not operate in these circumstances to include a benefit in the income of Parentco.

However, the CRA has announced a change to this administrative position. In a situation such as the one described above, the CRA now considers that subsection 15(1) will operate to include a benefit in the income of Parentco as a consequence of Subco paying the policy premiums. This benefit would be income from property.

The CRA stated that this change in its position is to be applied prospectively for new policies issued in 2010 and later. For policies already issued, the amount of the benefit incurred will be included in the shareholder’s income as of the 2011 calendar year. The CRA also noted that the General Anti-Avoidance Rule could apply to reduce the amount of Parentco’s CDA upon receipt of the proceeds of the life insurance policy unless there was a bona fide reason for the insurance holdings.

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.