Category: Tax

Categories
Immigration Real Estate Tax

Underused Housing Tax Act – Who Needs to File?

Introduction

The Government of Canada has introduced the Underused Housing Tax Act (UHTA) which came into effect on January 1, 2022. The filing and payment obligations generally apply to non-resident non-Canadian owners residential property, but some Canadian owners are also subject to filing obligations.

The filing due date is April 30th of the next calendar year and note that this is an annual filing. Significant penalties are imposed for failing to file an annual return; minimum of $5,000 for individuals and $10,000 for corporations. It is worth repeating, these penalties are for failure to file the return; even if you think the property is not subject to the tax because it is occupied, you might still need to file.

The definition of “residential property” and “owner” are relatively straight forward and can be read about here. One area of this Act that can catch people off guard is the definition of “excluded owner” and “affected owner” which is what I want to focus on here because that will determine the filing obligations.

Excluded Owner

Since I am writing for individuals and small business owners, I will only address the excluded owner definitions most relevant to you (hopefully). For details check out the other links in this post or contact us directly.

Excluded owners do not have to file or pay any taxes under the Act.

Canadian citizens and permanent residents are excluded owners unless they are the owner of residential property as either:

  • a trustee of a trust (except if you are the personal representative of a deceased individual, in which case you are an excluded owner of the residential property)
  • a partner of a partnership

One important group that is not excluded are private corporation holding residential property. This means holding companies owning residential real estate (ie. for the purpose of asset protection, financing, etc), will be required to file even if they are ultimately not liable for any tax under the Act. This means that whether the private corporation is owned by Canadians or not, it must file a return.

Affected Owners

Affected owners, as the name implies, is everyone affected by the Act which means all affected owners must at least file a return, and may potentially be required to pay the Underused Housing Tax.

The CRA defines affected owners as everyone who is not an “excluded owner” in the definition above. Some important examples of affected owners include:

  • Individuals who are not citizens or permanent residents of Canada
  • Canadian citizens and PR who are either acting as a trustee (other than as a personal representative of a deceased individual) or as a partner of a partnership
    • Note that the immigration status of the beneficiary or partner is not relevant, the affected owner must still file if everyone involved is Canadian or PR.
  • Private corporations whether Canadian or not.

March 27th 2023 Update

On March 27th 2023, the CRA announced that they would provide administrative relief for the 2022 tax year. The due date for the 2022 tax year is still May 1st 2023 but no penalties or interest will apply for UHT returns and payments that the CRA receives by October 31st 2023.

Additional Resources

Categories
Real Estate Tax

Anti-Flipping Measure Canada 2023

The new anti-flipping measure took effect in January 2023 and is another effort by the government to control real estate speculation in Canada, similar to the foreign buyer ban. If real estate is bought and sold within 365 days, the CRA deems the property to be “flipped property” and any profit from the transaction is treated as business income to the taxpayer. There are specific exemptions outlined below.

Background

The anti-flipping measure was put into place by Bill C-32 and amends the Income Tax Act (the “ITA“) to add a subsection specifically to deem proceeds from a “flipped property” as business income meaning 100% of the profit is included as income for the taxpayer. In the past, one of the advantages of transacting in real estate was that the profit could be treated as a capital gain and therefore only 50% of the profit would be taxed in the hands of the taxpayer.

Even before this anti-flipping measure, if a taxpayer flipped property, it would still generally be classified as business income. But taxpayers who did this in their personal capacity often reported any profits as a capital gain by justifying the real estate as an investment property and/or making use of the Principal Residence Exemption (more on that below). The new anti-flipping measure introduces a “bright-line rule” to prevent taxpayers from taking advantage of this grey area.

What is “Flipped Property”?

It is important to distinguish between the colloquial term we use everyday when we talk about “flipping property” and the CRA definition.

Colloquially, a simple definition of flipping property is the act of buying and selling a property quickly for profit.

In the anti-flipping measure, the CRA’s definition of “flipped property”: is any housing unit of a taxpayer that was owned for less than 365 consecutive days prior to the disposition of the property with several important exemptions. If the disposition occurred due to, or in anticipation of one or more of the following events, then it would not be considered flipped property:

  • death of a taxpayer or a person related to the taxpayer;
  • change in the taxpayer’s household in connection with a related person;
  • breakdown of a marriage or common-law partnership if the partners have been living separate and part for at least 90 days prior to disposition;
  • a threat to the personal safety of the taxpayer or a related person;
  • the taxpayer or a related person suffering from a serious illness or disability;
  • an eligible relocation (as defined in s248(1) of the ITA);
  • an involuntary termination of employment of the taxpayer or the taxpayer’s spouse or common-law partner;
  • the insolvency of the taxpayer; or
  • the destruction or expropriation of the property.

The CRA’s definition of “flipped property” tries to capture the colloquial definition while introducing a level of certainty by creating a strict cut off point (a “bright line”) of 365 days of ownership. While the cut off is somewhat arbitrary, it eliminates a lot of the grey area as the previous requirement was based on intent of the taxpayer.

The CRA also disallows any loss from a flipped property if it falls under this S12 deeming provision for flipped property. Note that if the property is inventory of the taxpayer (ie. in a business that purposely buys and flips property) the loss would not be denied. This new deeming provision is not meant to capture and “punish” a dedicated real estate flipping business as they already treat any profit as business income.

What about the Principal Residence Exemption?

The Principal Residence Exemption will not exempt the gain from a flipped property. Unless the taxpayer is selling due to one of the exemptions, even if the property they sell is their personal residence, the gain will not meet the Principal Residence Exemption because the proceeds are deemed business income due to this new anti-flipping measure. See paragraph 2.6 of Income Tax Folio S1-F3-C2 for a detailed explanation why.

Potential GST/HST Implications

The Excise Tax Act (the “ETA“) imposes an obligation to remit GST/HST on taxpayers who are considered a “builder” under the Act. A taxpayer can be considered a “builder” if they resell a newly constructed property (ie. buying and selling a pre-construction condo soon after closing) or sell a property in which they substantially renovated.

For taxpayers who have deemed flipped property business income and meet the builder definition of the ETA, they will be required to remit to the CRA GST/HST. This means that the transaction price of the property will be deemed to include GST/HST that the seller will need to remit to the CRA which will further erode the profit, if any, from a flipping transaction.

Tips

If a taxpayer is in the situation of selling within the 365 day ownership period due to one of the exemptions, they should retain documentation for proof. The taxpayer has the burden to prove to the CRA that an exemption applies if the taxpayer is audited. Furthermore, the taxpayer should consult with a tax professional to ensure that their situation and/or documentation is sufficient to meet the exemption. By consulting a professional and relying on their expertise, it also offers taxpayer a layer of protection as the taxpayer has done their due diligence.

The CRA implements several algorithmic tools to flag returns for audits. If a taxpayer has a history of claiming the Principal Residence Exemption frequently, it might flag their return for a questionnaire and potentially an audit. Note that the CRA can reassess a taxpayer’s T1 return up to three years after the original Notice of Assessment but if the CRA alleges fraud or misrepresentation, they can reassess further back. In these audits and reassessments the burden of proof is always on the taxpayer therefore it is vitally important to consult a tax professional as early as possible in the process. Whatever the taxpayer tells the CRA should be able to be corroborated or proven through documentation or third parties.

Taxpayers should keep in mind that even if a property is sold after the 365 holding period, the transaction might still be considered business income from a flip. The determination will be based on the facts of the situation.

The anti-flipping measure is coming at a difficult time for taxpayers. With the increase in interest rates and mortgage payments, some home owners may find themselves in a difficult position financially. If the home owner has owned the property for less than 365 days, they might be caught under this anti-flipping measure even if they do not think they are flipping property.

Categories
Immigration Real Estate Tax

Ontario Non-resident Speculation Tax (NRST) 2023

The Ontario Non-Resident Speculation Tax (NRST) has gone through several changes throughout 2022. This article will summarize the changes as of the end of 2022 going into 2023.

Summary of NRST changes throughout 2022.

  • Before March 30th 2022, the tax rate was 15% and it applied to the “Greater Golden Horseshoe” area. NRST rebate available for foreign nationals who become PR within four years, student enrolled for at least two years from the date of purchase, or legal full time working in Ontario for one year from the date of purchase.
  • From March 30th 2022 to October 25th 2022, the tax rate increased to 20% and it applied province wide. Rebate ONLY available for foreign nationals who become PR within four years.
  • Since October 25th 2022, the tax rate increased to 25%.

If you want to read the Ontario government’s information on the Non-Resident Speculation Tax, this is their official website.

Who is liable for the NRST

The NRST applies to foreign entities and taxable trustees that purchase certain types of residential property located in Ontario.

There is a transitional provision that exempts property outside of the Greater Golden Horseshoe if the agreement of purchase and sale was entered into before March 30th 2022.

Foreign entities include individuals who are not Canadian citizens or permanent residents and foreign corporations. Taxable trustees are those who have at least one trustee who is a foreign entity or a beneficiary of the trust is a foreign entity.

Property subject to the NRST

The NRST applies to property that contains at least one, but less than seven, single family residences. Single family residences include detached houses, semi-detached houses, townhouses, and condominium units. This also includes duplexes, triplexes, fourplexes, fiveplexes, and sixplexes.

Therefore, buildings that contain seven or more single family residences (ie. rental apartments), commercial, vacant, and industrial land are excluded from the tax.

How the NRST is calculated and paid

The NRST rate is 25% of the value of the consideration for the residential property. In most cases, this will be the agreed upon sale price on the APS.

Again, transitional provisions apply to if the APS was entered into prior to the dates outlined above.

The NRST also applies to 100% of the value of the consideration even if the foreign entity only owns a portion of the property being purchased. Each purchaser is jointly and severally liable for any NRST payable.

The NRST will be paid as part of the lawyer closing process. The transferee will need to provide the lawyer with the NRST amount with the down payment of the property.

NRST Exemptions

The following NRST exemptions apply and they have not changed throughout 2022:

  • If the foreign national is a nominee of the Ontario Immigrant Nominee Program at the time of purchase and the property is used as the foreign national’s principal residence.
  • If the foreign national is a convention refugee under IRPA at the time of of purchase.
  • If the foreign national is jointly purchasing with a spouse who is a Canadian citizen, permanent resident, Ontario Immigrant Nominee Program nominee, or refugee.
NRST Rebates

If a foreign national bought a property after March 29th, 2022, the only rebate available is if the foreign national becomes a Canadian permanent resident within four years of the date of purchase. The date of purchase meaning the closing date of the property transaction when the transfer/deed is registered by the lawyer.

The requirements of the permanent resident rebate are as follows:

  • the foreign national must become a Canadian permanent resident within four years of the date of purchase,
  • the property must be owned only by the foreign national or by the foreign national with their spouse,
  • the property must be used as the foreign national’s principal residence for the entire period, and
  • the rebate application must be received by the Ontario Ministry of Finance within 90 days of the foreign national becoming a permanent resident of Canada.
NRST Rebate transitional provisions

Transitional provisions apply for the student and worker rebates if the APS was entered into prior to March 29th 2022 but the complete application must be submitted by the earlier of:

  • four years after the date of purchase, or
  • March 31st, 2025.
NRST Rebate Application Procedure

When we apply for the NRST rebate, we usually include it with any Land Transfer Tax (LTT) rebate for first time home buyers if applicable (see below for more details on timeline).

A complete rebate application should have the following:

  • Ontario Land Transfer Tax Refund/Rebate Affidavit
  • Registered transfer
  • APS, and/or assignment documents with all schedules attached.
  • Statement of Adjustment
  • Proof of payment of the LTT and NRST
  • Proof of occupancy as principal residence with 60 days of closing
  • Proof of status as permanent resident (or fulfilment of study or work requirements if applying for the transitional rebates)

In most cases, the applicant should have most of the documents required to submit the rebate application but if not, they should follow up with the lawyer they used for closing who will have the Transfer, statement of adjustment, Teraview docket summary, etc. Note that most lawyers will charge an additional legal for the rebate application process because it is not included in their original retainer.

Proof of occupancy could include utility, phone, credit card statements, delivery slips, moving invoice, etc. that support the use of the property as the foreign nationals principal residence throughout the ownership period. The government gives a grace period of 60 days but it is expected that the applicant must be able to prove they moved into the property within this time.

Proof of status for permanent resident status would be a PR card or the Confirmation of PR document.

For the transitional rebate provisions for students, a study permit, an official transcript showing full time study for two years after the date of purchase and invoices to show tuition payments is generally sufficient. A school letter confirming enrollment would also be advisable in some situations.

For the transitional rebate provision for workers, work permit, T4s, pay stubs, and an employer letter confirming employment is generally sufficient.

Other Considerations

If the foreign national is also a first-time home buyer, they may be eligible for the LTT rebate from Ontario and/or Toronto if applicable. The rebate only applies if the foreign national becomes a permanent resident and the deadline for application is more strict than the NRST. The deadline to apply for the LTT rebate for first time home buyers is within 18 months of the date of purchase.

It is very important to make sure these rebate applications are complete because processing time can take almost a full year. If an incomplete application is submitted, it could take months before the problem is detected and by that time, the time limits above could be exceeded. If you need help, please reach out to us.

To stay up to date on any future changes to the NRST or to stay up to date on global mobility issues, sign up to our newsletter using the form below.

Categories
Tax Real Estate

2022 Changes to GST/HST on Assignments

The 2022 Federal budget included a few changes to the way some real estate transactions are taxed. The two mains changes are the new residential property flipping rule and changes to the way GST/HST on assignments is taxed for individual. In this post I will be discussing the latter.

Summary of the changes to GST/HST on assignments effective May 7th 2022:

  1. The new change makes it so that there is GST/HST on assignments regardless of original intentions. Previously, if the original intention of entering the pre-construction contract/Agreement of Purchase and Sale (APS) was for personal use, GST/HST on assignments did not apply. But if the intention was to sell for profit or flip the property, GST/HST applied.
  2. The legislation officially recognizes that GST/HST is not payable on the portion of the consideration exchanged that represents the deposit that the assignor paid to the seller/builder.

I have seen people talk about these changes as if it will slow down the housing market because they seem to incorrectly assume that GST/HST on assignments is double levied or increased. The changes actually add certainty to the way GST/HST on assignments are taxed.

Let’s do an example of pre- and post- May 7th 2022 changes. Here is the assignment details (closely maps on to OREA Form 145/150 Schedule B):

  • Purchase Price on the original APS = $1,000,000
  • Payment by Assignee to Assignor for this Assignment Agreement = $100,000*
  • Total Purchase Price including the Original APS and this Assignment Agreement: $1,100,000
  • Deposit paid by the Assignor to the seller under the original APS to be paid by the Assignee to the Assignor: $200,000

**For the sake of simplicity, this excludes GST/HST but in practice, most assignment agreements will stipulate that GST/HST is included

Under the pre-May 7th 2022 rules according to the CRA*, GST/HST would have been payable on the whole amount that the assignee pays to the assignor, $300,000, which results in HST payable of $39,000 in Ontario (13%*300,000).

*Note that it was the CRA’s view that GST/HST is levied on the deposit. In reality this was challenged successfully in a 2013 Tax Court case and a taxpayer can file their GST/HST return without including the amount attributable to the deposit. But the CRA continued to levy GST/HST on the deposit amount in audits and reassessments so taxpayers unaware of the Tax Court ruling would end up paying additional GST/HST.

Under the post-May 7th 2022 rules, GST/HST on assignments is officially only payable on the payment by the assignee to the assignor, $100,000, which results in HST payable of $13,000 in Ontario. This will force the CRA to update their practice guidelines and hopefully they will no longer expect GST/HST on deposits in audits and reassessments.

The Nitty-Gritty

Lately, I have seen a lot of incorrect information shared by investors, agents, accountants, and lawyers regarding the new GST/HST changes so I hope that this post can put to rest any uncertainty on this issue by giving concrete examples and referring to the budget documents (the link goes to the Supplementary Information attached to the Federal Budget).

Many people are confused about the new changes to GST/HST on assignments and I think it largely stems from the imprecise use of language when talking about assignment agreements.

Before we begin, let’s start with some general definitions I will use in this post and are relevant in assignments:

  • APS = Agreement of Purchase of Sale = Pre-Construction Contract
  • Buyer = Assignor. The buyer is the individual who signed APS to buy the property. They will also be the assignor in the assignment agreement by assigning the APS to the assignee.
  • Seller = Builder. The seller is the builder who signed the APS to sell the property. Note that most pre-construction agreements have a clause that give the seller some rights in an assignment of the contract (ie. seek seller permission and/or an assignment fee).
  • Assignee = first occupant. The assignee is the person who will be assigned the APS and wants to eventually close on the property and live in it therefore, in most cases, they will be the first occupant.
  • Taxable Supply – means a supply that is made in the course of a commercial activity (from the Excise Tax Act (the “ETA“) S123(1))
  • Budget Day – April 7th 2022.

There are two main paragraphs most relevant to the new changes and I will explain what both of them mean. The first:

Budget 2022 proposes to amend the Excise Tax Act to make all assignment sales in respect of newly constructed or substantially renovated residential housing taxable for GST/HST purposes. As a result, the GST/HST would apply to the total amount paid for a new home by its first occupant and there would be greater certainty regarding the GST/HST treatment of assignment sales.

Supplementary Information for the 2022 Federal Budget (https://budget.gc.ca/2022/report-rapport/tm-mf-en.html#a5_2)

I believe some people have misinterpreted this paragraph, specifically the underlined section. The total amount paid by the first occupant is the purchase price on the APS (net of GST/HST as it is usually included in the price) plus the amount the first occupant/assignee paid for the assignment contract (also net of GST/HST).

The legislators have reframed the GST/HST on assignment sales from a taxable supply provided by the assignor, to the GST/HST owed because that is the “true purchase price” that the first occupant paid for the property. There is no double taxation. The amount of GST/HST on assignments is just being levied on the original APS price plus the additional amount the assignee paid to the assignor.

Which leads to the next paragraph:

Typically, the consideration for an assignment sale includes an amount attributable to a deposit that had previously been paid to the builder by the assignor. Since the deposit would already be subject to GST/HST when applied by the builder to the purchase price on closing, Budget 2022 proposes that the amount attributable to the deposit be excluded from the consideration for a taxable assignment sale.

Supplementary Information for the 2022 Federal Budget (https://budget.gc.ca/2022/report-rapport/tm-mf-en.html#a5_2)

The GST/HST on the deposit never made sense because the assignee was essentially returning the deposit that the assignor already paid to the builder which was already subject to GST/HST in the APS. This new reframing of the assignment sale solves that quirk because the deposit is already accounted for in the assignee’s “true purchase price”.

The Nittier-Grittier

So this is where going to law school comes in handy. If the above has not convinced you, please read on but otherwise, this might be a bit dense as I convert each part of the change to the ETA in everyday language that even a non-tax lawyer can understand (hopefully).

Supplementary Information for the 2022 Budget (https://budget.gc.ca/2022/report-rapport/nwmm-amvm-02-en.html)

If a taxable supply by way of sale of a single unit residential complex (as defined in subsection 254(1)) or of a residential condominium unit is made in Canada under an agreement of purchase and sale (in this section referred to as the “purchase agreement”) entered into with a builder of the single unit residential complex or of the residential condominium unit […]

Translation/simplification: If a taxable supply by way of an APS is entered into …

[…]and if another supply by way of assignment of the purchase agreement is made by a person (other than the builder) under another agreement, then the following rules apply for the purposes of this Part:

Translation/simplification: …and if there is another supply (profit from the assignment) by way of the assignment of the APS, then the following rules apply:

(a)  the other supply is deemed to be a taxable supply, by way of sale, of real property that is an interest in the single unit residential complex or residential condominium unit; and

They key phrase here is “other supply” because it does not refer to the original taxable supply which would have been the entire purchase price of the property in the APS. Instead, the “other supply” refers to the profit the assignor made in assigning the APS to the assignee.

Translation/simplification: (a) the profit from the assignment agreement is deemed to be a taxable supply.

(b)  the consideration for the other supply is deemed to be equal to the amount determined by the formula A-B where

Translation/simplification: (b) the profit from the assignment agreement is determined by the following formula A-B where

A is the consideration for the other supply as otherwise determined for the purposes of this Part, and

Translation/simplification: A is the total amount the assignor received before HST, and

B is

(i)  if the other agreement indicates in writing that a part of the consideration for the other supply is attributable to the reimbursement of a deposit paid under the purchase agreement, the part of the consideration for the other supply, as otherwise determined for the purposes of this Part, that is solely attributable to the reimbursement of the deposit paid under the purchase agreement, and

(ii)  in any other case, zero.

Translation/simplification: B is a reimbursement from the assignee to the assignor for the deposit paid in the APS if applicable

And putting it all together:

If a taxable supply by way of an APS is entered into and if there is another supply (profit from the assignment) by way of the assignment of the APS, then the following rules apply

(a) the profit from the assignment agreement is deemed to be a taxable supply.

(b) the profit from the assignment agreement is determined by the following formula A-B where

  • A is the total amount the assignor received before HST, and
  • B is a reimbursement from the assignee to the assignor for the deposit paid in the preconstruction agreement if applicable

Conclusion

This new change introduces more certainty and logic into the tax code which is good for society overall.

Realistically, this only disadvantages those who have a change in circumstance and are “forced” to assign their property before closing. For example, this could be due to interest rate hikes that prevent a taxpayer from obtaining a mortgage or getting a new job elsewhere and no longer needing the property.

But it does create a positive incentive for real estate flippers to follow the law as it closes off one of the avenues for avoiding GST/HST on assignments (though income tax is a whole other issue). I don’t think it will have any meaningful effect on house prices, unless people believe in the incorrect information.

Categories
Estates Real Estate Tax

Bare Trusts

Bare Trusts are an important tax and estate planning tool that can be used in many contexts. A common example where bare trusts would be useful is in real estate transactions where a parent is on title with the child for mortgage reasons but the intention is for the child to have full ownership of the property.

In law, there are two types of ownership of property. There is the “legal ownership” or “legal title” of the property which is generally held by the person whose name is registered with that property. The second type of ownership is “beneficial ownership”. The beneficial owner is the person who is entitled to the benefits (ie. capital, income, use) of the property.

In most cases, the legal and beneficial owner is the same person (ie. I own a bank account or house for my own uses). But there can be situations where legal and beneficial ownership are split whether intentionally or unintentionally (ie. my name is on the title of a house with my child but my child pays the mortgage and uses it exclusively).

To summarize, a bare trust involves three parties:

  • The settlor(s) in a bare trust is the beneficiary(s). In other trusts, these parties are often separate.
  • The trustee(s) who hold legal ownership. In a bare trust (unlike other trusts), the trustee has no independent power, or responsibility for dealing with the trust property. Their only role is to hold legal title.
  • The beneficiary(s) who hold beneficial ownership. In a bare trust, the beneficiary has the right to the capital, assets, and income of the trust property. The beneficiary is also the person who will be the decision maker for dealing with the trust property.

A bare trust agreement drafted by a lawyer is important because it establishes a legitimate bare trust relationship between the parties. If there is a future dispute as to whether a bare trust exists between the parties, the trust agreement would be the primary proof that such a relationship exists. A properly executed trust document is the best defense to the CRA or other parties alleging an alternative arrangement.

Some potential issues to think about:

  • A trustee in a bare trust has very limited responsibilities with respect to the trust property, but this is not necessarily true in other trust relationships. A bare trust agreement will establish the responsibilities of all parties and limit the liability of the trustee while also protecting the beneficiaries rights.
  • There are a variety of uses for bare trusts in real estate transactions: minimizing land transfer taxes, joint ventures and partnerships, estate planning, etc.
  • On February 4th 2022, there is draft legislation that proposes new tax reporting requirements for bare trusts. The legislation is not finalized so exact reporting requirements are not known at the moment (written April 27th 2022). If there are reporting requirements, bare trusts could result in some additional tax filing obligations and expenses.

If you think a bare trust might be a suitable tool for your real estate or estate planning needs, please reach out for a consultation.

Categories
Real Estate Tax

New NRST Changes as of March 30th 2022

Read the Ministry of Finance bulletin here.

There will be a transitional period for Agreements of Purchase and Sale entered before March 30th 2022. The previous Non-Resident Speculation Tax (NRST) rate of 15% for the Golden Horseshoe Region applies for any APS entered prior to the aforementioned date. The new NRST changes were implemented by the Ontario government to reduce foreign demand for Ontario housing in the hopes of slowing down the housing market.

Any foreign national (individuals who are not Canadian citizens or permanent residents of Canada) who purchases property in Ontario will be subject to the 20% NRST from March 30th onward.

Furthermore, the NRST rebate for International Students and Foreign Nationals Working in Ontario no longer applies from March 30th 2022 onwards. If you were relying on this rebate and the agreement was entered into prior to March 30th, you can still claim the rebate but the application must be submitted before March 31st 2025.

If you are still eligible to claim an NRST rebate under the old rules before the new NRST changes, please contact us. We help people apply for rebates of both the NRST and LTT (Ontario and Toronto). As of November 2022, these rebate applications are taking almost one year to process from the time of submitting the documentation. It is vitally important to provide the appropriate evidence necessary for the application to avoid further delay or rejection especially as there is now a new deadline for applying for such rebates; March 31st 2025.

Categories
Real Estate Tax

S45(1) Change in Use of Your Principal Residence

When you have a change in use of a property from being your principal residence to a rental property or vice versa, s45(1) of the Income Tax Act deems that a disposition of the property has occurred. For more information, please see our post regarding the principal residence exemption.

A s45(2) election may be applicable when the change in use is from your principal residence to a rental property. S45(2) postpones the change of use deemed disposition and allows you to maintain the principal residence designation on your home for up to four years after you have stopped living in it. This post will discuss the requirements for the election to be valid and the resulting tax implications.

I will also go over the s45(3) election used when you have a change in use from an income property to your principal residence at the end of this post.

Who can make a s45(2) election?

You must not designate any other property as your principal residence and you must be a resident or deemed to be a resident of Canada. Residency determination of a taxpayer is another big topic for another post. But you do not have to be a permanent resident or citizen of Canada to be resident of Canada. The determination is based on the facts of circumstances of each case.

When to make a s45(2) election?

The s45(2) election should be made during the taxation year in which the change in use occurred. Intuitively, this makes sense, if the s45(2) election was not made you would have to report a disposition of your principal residence on your tax filing for the year.

The CRA allows you to file a late s45(2) election but you may be subject to penalties. Furthermore, you cannot claim Capital Cost Allowance during the period when the property was used for income purposes that you want to claim principal residence exemption on. You should contact us if you plan to make a late election, there could be penalties if the request is seen as retroactive tax planning, there is inadequate documentation, or you are considered negligent in complying with the law.

Tax implications of a s45(2) election

Since you are only allowed to designate one principal residence per family unit, if you decide to make an s45(2) election, you will not be able to designate any other property during that period as your principal residence. Careful consideration should be put into the current and future valuation of the property subject to the election and any other property you own.

Extension of a s45(2) election

The standard s45(2) election allows the principal residence exemption to cover four additional years where you do not live in the property. If the following conditions are met, the four year limit can be extended indefinitely:

  • You moved because you or your spouse/common-law partner’s employer wants you to relocate.
  • You are your spouse/common-law partner are not related to the employer.
  • You return to your original home while you or your spouse/common-law partner are still with the same employer, OR before the end of the year following the year in which this employment ends, OR you die during the term of employment.
  • Your original home is at least 40km farther than your temporary residence from you or your spouse/common-law partner’s new place of employment.

You should be retaining and collecting documentation in support of any of the above conditions in case the CRA audits your election. If you are audited for such an election please contact us as these disputes are very fact specific.

Section 45(3) Election

A s45(3) election may be beneficial when the change in use is from an income producing property (rental property) to your principal residence. A successful election will allow you to declare a property your principal residence for up to 4 years before the change in use occurs.

For example, say you have a rental property that has been rented for 5 years that you moved back into as your principal residence for 2 more years before finally selling it. A s45(3) election will allow you to declare the subject property your principal residence for 6 years instead of just 2 years if the election was never made. This could be a huge tax saving.

Furthermore, an s45(3) election eliminates the deemed disposition that would otherwise be required by the CRA in a change in use scenario. You still need to consider the value of the property at the time of the change in use (and expected change in value in the future) to determine whether a s45(3) election is worth it in your scenario. In some scenarios, an s45(3) election might result in a much higher tax burden therefore a careful calculation with an accountant or tax planning lawyer should be conducted.

Similar to the s45(2) election, the s45(3) election is only available if CCA was not claimed on the property. And again, if you have more than one property, you should consider whether the principal residence exemption is more valuable on one property over another.

Unlike the s45(2) election, the s45(3) election is made in the tax year in which the property is actually disposed of, NOT the year in which the change in use occurs.

Conclusion

S45(1) change in use dispositions can seem like a headache but the elections covered above offer some substantial tax savings and tax planning opportunities. This article only covers the main considerations in such an election. To properly consider whether you should make an election we need to calculate the tax savings, consider opportunity costs, tax residency, and a variety of other legal matters. If you are considering such an election or have further questions, please contact us!

Information current as of December 13th 2022.

Categories
Incorporation Real Estate Tax

The Principal Residence Exemption

A house is often a person’s most valuable asset, making the principal residence exemption the biggest tax break most people can get. What most people are not clear about is when your house can be considered your principal residence. For example:

  • If I rented out a part of my house, can I still claim a principal residence exemption? (yes, but it depends)
  • I started renting out my house and no longer live there, does that mean I have made a deemed disposition of my principal residence? (no, but it depends)
  • If I only lived in the house for a few days in a year, can it still be considered my principal residence? (yes, but it depends)

They key is always in the details and hopefully this post will shed some light on when the principal residence exemption is actually applicable.

First of all, all this information is freely available in the CRA’s Income Tax Folio S1-F3-C2 on the topic of principal residence. Be forewarned that it is a length webpage but it is thorough and may cover specific situations not covered in this post. It should be noted that from a legal perspective, the CRA Income Tax Folio’s are only the CRA’s interpretation of the Income Tax Act. When we create a tax plan or represent you in a tax dispute, we also rely on case law and other legal arguments which produce a more favourable interpretation of the Income Tax Act specific to your situation. If you have a specific situation in mind please contact us.

With that being said, let’s go over some topics that frequently come up when we talk about the principal residence exemption.

The principal residence exemption only exempts capital gains

You should keep in mind that if the CRA claims that the sale of your property resulted in business income and not capital gains, then the principal residence exemption will not apply whether you lived in the property or not. This is because a precondition for the exemption is that the income must be a capital gain.

The CRA may reassess a sale as business income based on several factors which they use to imply a house flipping transaction. Not only would you lose the exemption, but 100% of the profit will be taxes based on your marginal tax rate and you will liable to pay HST/GST with interest.

Ownership considerations

To claim the principal residence exemption on the sale of a property you must own the property. This might seem obvious but there are several further implications.

In a situation where the title of the property is held as joint tenants between several people; upon the sale of the property, the capital gain will generally be split between the parties equally. The principal residence exemption will only be available to the taxpayer who can meet the requirements to designate the property as their principal residence. The same applies for property owned as tenants-in-common subject to whatever percentage ownership on title.*

Who can use the principal residence exemption?

You can only designate one principal residence for a particular tax year for your family unit. Note that it is family unit and not individual, this has both advantages and disadvantages. Advantage, you can designate a property you do not live in, but a member of your family unit lives in, as your principal residence. Disadvantage, you cannot designate multiple principal residences among your family unit.

A family unit consists of:

  • You
  • Your spouse or common-law partner throughout the year, unless the spouse or common-law partner was living part due to a judicial separation or separation agreement.
  • Your child, except those who are married, in a common-law partnership, or 18 years or older.
  • If you are 17 years or younger and are not married or in a common-law partnership: your parents and siblings who are not married, in a common-law relationship, or 18 years or older.

The ordinarily inhabited rule

This is usually where people get confused because there is a lot of grey area in determining whether a property is ordinarily inhabited by a member of your family unit. There is the obvious situations, where you live at the property throughout the ownership period. But depending on the circumstances, the exemption could also be applicable if your child intended to live in the property but never got the chance. It comes down to the reason you owned the property in the taxation year you are claiming the exemption. But since people very rarely write down the exact reason we do certain things, we can usually only offer circumstantial evidence that hints at the reason. This is why record-keeping for these tricky situations is so important and why a dispute with the CRA requires very careful and structured arguments.

Generally speaking, if the evidence shows that the main reason you owned a property is for profit or income production, then it will generally not be considered ordinarily inhabited; the capital gain attributed to that year may not be exempted by the principal residence exemption. Or if the evidence suggests that the property was acquired with the intention of flipping for a profit, the entire gain may be considered business income.

What if I rented out only a part of my home?

This is another grey area. The general rule is that if you are renting out a part of your principal residence, then that portion of the property is not covered by the exemption. For example, this would apply if you had a commercial store front as part of the property.

There is an exception for people who rent out their basement or a bedroom in their house. If the following conditions are met, the principal residence exemption will apply to the entire property:

  • The income-producing use is ancillary to the main use of the property as a residence.
  • There is no structural change to the property to make it more suitable for rental purposes.
  • No Capital Cost Allowance is claimed on the property.

Change in use

When you go from living in your property to renting it out, there is a change in use. For tax purposes under s45(1) of the Income Tax Act, you are deemed to have disposed of it at fair market value and reacquired it at the same price. This deemed disposition updates your adjusted cost base for calculation future capital gains which will not be shielded by the principal residence exemption. You are required to report this change oinuse in the tax filing of the year of the change.

There are two ways to postpone the deemed change of use from principal residence to income property:

  1. A s45(2) election which allows you to keep the principal residence declaration on the property even after you move out for up to four years, and
  2. S54.1 also allows the principal residence exemption if you move due to requirements to relocate due to employment.

Both of these are extremely valuable in tax planning but there are specific requirements and there may be adverse tax consequences. The links above will go to a post with more details.

You can also postpone a change of use deemed disposition when going from an income property to your principal residence with a s45(3) election. In this situation, the property may be designated as the principal residence for a period of up to four years before the change of use. This election too has its own set of requirements.

If you have any further questions, please contact us.

Information current as of December 4th 2020.

* Off-topic but I think it bears mentioning. This is an especially important consideration in an estate plan. In an attempt to avoid probate fees, some people might want to include a child on title of their principal residence as a joint tenant. But if this occurs, the transferring parent will be deemed to have disposed of half their interest in the property and any gain on the half owned by the child will no longer be subject to the principal residence exemption if the property is not the child’s principal residence. The taxable portion of the capital gain could be significantly more than any probate fees saved.

Categories
Business Incorporation Tax

CRA House Flipping Audit Decision

In recent years, the CRA has taken a more aggressive and proactive approach in auditing transactions in the real estate sector, especially house flipping. If you have investments in real estate you should pay attention to a recent decision issued by the Tax Court of Canada, Hansen v. The Queen on September 14th 2020. Many of these types of cases get settled before getting to court so when such a case actually gets to trial it is worth investigating further.

Overview

The CRA issued a reassessment on Mr. Hansen’s return around 2013-2014 for taxation years, 2007, 2008, 2009, 2011, and 2012. The CRA alleges that Mr. Hansen was involved in house flipping and that the numerous properties sold did not fall under the principal residence exemption which he claimed. In total, five houses and one vacant lot were sold by Mr. Hansen.

The decision of the court linked above provides many detailed facts which are worth reading to understand the context of the decision. To quickly summarize, most of the reasons for the sale of the houses were for the welfare of the Hansen’s two adopted daughters. Mr. Hansen has a sympathetic narrative which the court considered credible. We do not know all the evidence provided by Mr. Hansen, but testimony from his accountant, and affidavits and statements from neighbours were mentioned.

Main issues

There were several issues decided by the court but I’ll discuss the most important ones for future tax planning.

1. Was the CRA entitled to reassess the 2007, 2008, and 2009 tax years which were outside the normal assessment period?

The normal assessment period for an individual taxpayer is typically three years after the date of the notice of assessment or the last reassessment. If the CRA wants to reassess returns beyond this period, the CRA must establish on a balance of probability* that the taxpayer made a misrepresentation attributable to neglect, carelessness, or wilful default.

2. Whether the gains from the sale of the houses was business income or an adventure in the nature of trade.

If the income is reassessed as business income, the taxpayer loses the principal residence exemption AND the capital gain tax treatment. Instead of 50% of the gains being taxable, 100% of the gain will be taxed as business income. Furthermore, the taxpayer will owe GST on the transaction. Mr. Hansen must establish on a balance of probability that the income falls under the principal residence exemption.

3. Whether s163(2) penalties apply.

The CRA may impose s163(2) penalties on taxpayers who knowingly or under circumstances amounting to gross negligence make, participate in, asset to, or acquiesce in the making of a false statement or omission in a tax return. The penalty is the greater of $100 or 50% of the additional tax payable with the reassessment. This is a heavy penalty. For example, if you are reassessed to owe an additional $100,000, the s163(2) penalty would be $50,000 making the total amount payable $150,000. The CRA must establish on a balance of probability that the the taxpayer has acted with gross negligence.

Outcome and commentary

1.The CRA could not reassess 2007, 2008, 2009 tax years.

The court held that the CRA did not prove, on a balance of probabilities, that Mr. Hansen made a misrepresentation attributable to neglect, carelessness, or wilful default.

This goes to show that even a history of transactions which the CRA might characterize as a history of improper characterization of income does not on its own necessarily demonstrate that the taxpayer has made a misrepresentation.

Below is a selection of the cases the court cited to support this position:

– Savard v. The Queen: The taxpayer has the right to disagree with the CRA in their interpretation of the Income Tax Act without this necessarily being considered a misrepresentation.

– Regina Shoppers Mall Ltd. v. The Queen: There is no misrepresentation when a taxpayer thoughtfully, deliberately, and carefully assesses the situation

– Chaumont v. The Queen: Taxpayer’s interpretation was incorrect, but it was neither far-fetched nor unreasonable enough to conclude that it was a wilful default or mistake with the intent to escape from his tax obligations

In this case, Mr. Hansen gave a reasonable explanation for the disposition of the property in the years outside the normal assessment period. Presumably, there were few inconsistencies in his testimony and there was documented proof of his claims which is why the court believed it was a credible narrative. The CRA did not provide sufficient evidence that Mr. Hansen tried to deceive the CRA in his tax filing.

Ultimately, the court did not determine whether the taxpayer was correct in designating the properties sold in 2007, 2008, and 2009 as principal residences since the CRA was barred from reassessing those years. But based on the court’s reasoning, even if the taxpayer was incorrect and the gains should have been reported as business income, the CRA would not be able to reassess those years since the CRA did not provide sufficient evidence of misrepresentation.

My personal opinion on this issue is that it could have easily gone in the CRA’s favour and really depended on the court’s weighing of the evidence. This issue is probably why the case did not settle and went to trial.

2. The principal residence exemptions did not apply for the properties sold in 2011 and 2012.

The court held that the Mr. Hansen did not meet the burden of proving the properties were a capital asset, where the proceeds would be considered a capital gain and potentially sheltered with the principal residence exemption, or as an adventure in the nature of trade.

The factors in this determination were laid out in Happy Valley Farm Ltd. v. MNR: Nature of the property sold, Length of ownership, Frequency of similar transactions, Effort expended in bringing the property into a more marketable condition, Circumstances responsible for the sale of the property, Intention at the time of acquiring the property.

The court’s held that Mr. Hansen had an intention to profit from the sale of the property when he acquired the property. Furthermore, the court again reiterated that a primary intention to profit is not necessary. Even if you establish that you had a primary intention of using the property as a capital asset, if there is sufficient evidence to establish a secondary intent to profit, that might be enough to weigh the “intention factor” towards a determination of an income asset.

3. S163(2) penalties did not apply.

Since the CRA did not establish that Mr. Hansen made a misrepresentation for the 2007, 2008, and 2009 tax years, s163(2) penalties were not applicable for those years.

The court held that Mr. Hansen made a false statement in claiming the principal residence exemption for the 2011 and 2012 properties sold.

But the court held that the CRA did not meet the burden in establishing that Mr. Hansen made the false statement knowingly or in circumstances amounting to gross negligence.

Again, the court relied on the credible testimony and evidence provided by Mr. Hansen. Mr. Hansen’s testimony provided a non-farfetched explanation for his incorrect interpretation of the Income Tax Act. Mr. Hansen also used a CPA for his tax filings. The CPA’s testimony indicated that Mr. Hansen provided the necessary information for the CPA to advise Mr. Hansen that the principal residence exemption was applicable. The court held that it was reasonable for Mr. Hansen to rely on the CPA’s advice.

Takeaways

Regarding assessments outside the normal assessment period.

  • Be aware of the normal assessment period. The normal assessment period outlined in s152(4) of the Income Tax Act is an important protection for the taxpayer. If the CRA reassesses a year outside the normal assessment period, this ground for dispute should always be at the forefront of your objection. I have seen far too many situations where a taxpayer has disputed the substance of the CRA’s reassessment without considering their rights outside the normal assessment period.
  • A history of incorrect/false tax filings does not, on its own, or even with additional supporting evidence, indicate misrepresentation. I think this case is a great example of this. Mr. Hansen bought and sold five houses and even a vacant lot. Mr. Hansen was essentially the general contractor for several of the houses he built and sold. General contractors are considered experienced real estate professionals and often are looked at with more scrutiny since they are more knowledgeable in the industry. These factors in favour of the CRA’s position can still be overridden which brings me to…..
  • A taxpayer’s well documented and thoughtful consideration of his interpretation is key. The central question is whether the taxpayer carefully considered his position AND attempted to deceive the CRA. The CRA must prove misrepresentation but you should keep in mind that the court still looks at the reasons you provide for reaching your position. Therefore, having a clear outline of your narrative and providing supporting evidence to support your position is vitally important especially at the objection stage where you can prevent the dispute from escalating further to an expensive appeal.

Regarding the characterization of a capital asset vs adventure in the nature of trade.

  • Intention of the taxpayer at the time of acquisition is the single biggest determining factor. If there is an intention, whether primary or not, to profit from the sale of a house at the time of acquisition, the transaction will likely be considered an adventure in the nature of trade. Since there is often very little physical evidence of your intention at the time of acquisition, the most important evidence is a credible testimony and providing circumstantial evidence to support your real intention, which presumably is not to profit from the sale of the house.

Regarding s163(2) penalties.

  • It is reasonable to rely on a tax professional’s advice. It should be noted that the tax professional should have the full picture of your situation to give the proper advice. It follows that it is less reasonable to rely on the tax advice provided by your “uncle who is a really good business man”.

Seek Professional Help.

If you receive a call from the CRA asking for additional information about previous real estate dispositions, chances are that the CRA has either obtained information from a third party or that your previous tax filings has triggered a red flag which has resulted in an audit.

Before answering any questions, seek professional help.

The CRA will likely call and tell you that they will be sending you a questionnaire, you should not fill out this questionnaire before consulting a professional. We have seen far too many clients dig themselves a hole that took years of negotiations with the CRA to resolve.

*In the legal context, a balance of probability means “more likely than not” or numerically speaking, more than 50% chance that something is true. This is in contrast to “beyond a reasonable doubt” which is often applicable in criminal cases.

Categories
Business Estates Tax

Family Trusts: The Basics

I work with many new immigrants and small business owners and I find that many people have similar questions and misunderstandings of the Canadian tax system. This post will be part of a series which addresses some of these common questions.

We have all heard the term “trust fund kid”, but what exactly is a trust fund and is it something only the ultra wealthy can take advantage of?

There are many types of trusts. A trust describes a relationship between several parties where a person, the settlor, gives another person, the trustee, the right to hold title to assets (ie. real estate, corporate stocks, bonds, cash, etc) for the benefit of beneficiaries. There are many types of trusts but this article will focus on the family trust, the type of trust that most people are referring to when talking about “trust fund kids”.

To create a family trust, legal ownership of assets must be transferred into the trust by the settlor. The people who stand to benefit from the trust fund are the beneficiaries.

There is also a separate person(s) who manage the trust, called the trustee(s). The trustee must be a separate person from the settlor and have a certain level of autonomy from the settlor. The trustee must act in the best interests of the beneficiaries and in accordance with the trust agreement. The trust agreement is the formal agreement which establishes the trust. The trust agreement is created by the settlor and his lawyer to ensure that the trust is valid and that it will carry out the intentions of the settlor*.

Furthermore, the settlor no longer has the legal right of ownership and control over the transferred assets, that right of ownership and control now belongs to the trustee. Depending on the asset and the objective of the settlor, this loss of control can be prevented. I will discuss this in a future post on estate freezes.

The main uses of a family trust

1. Reduce the total tax payable on an asset

The settlor can reduce the amount of tax he must pay on the sale of an asset in the future by setting up a family trust. The transfer of the asset “freezes” the value of the asset at the time of transfer for the settlor. That means that all future accumulation of value in the asset will not be taxed in the settlor’s hands, but instead distributed between the beneficiaries who presumably are in a lower tax bracket.**

The use of a family trust also allows other members of your family to take advantage of the Lifetime Capital Gains Exemption (LCGE). Every individual has a LCGE where $883,384 (as of 2020) of any gain from the disposition of a qualified small business corporation (QSBC) is exempt from taxation. If the QSBC shares are held by the trust, the beneficiaries can each exempt their portion of the shares thus shielding more of the shares from capital gains compared to the situation where the shares were all held by one person.

2. Plan the transfer of wealth

A family trust is an estate planning tool to transfer wealth to other family members. A family trust is an alternative to giving the assets directly to the intended beneficiaries; something that might not be possible or desired if the intended beneficiary is a minor or not responsible enough to directly own the asset. By using a family trust, the trustee is the person who manages the asset for the benefit of the beneficiary. Since the settlor chooses who the trustee will be, they can put control of the assets in the hands of someone who the settlor knows will manage the asset responsibly.

3. Protection of assets

The assets transferred to a trust are generally protected from the claims by the settlor for any lawsuits or bankruptcies, similar to the protection of assets transferred to a corporation.

The drawbacks of a family trust

1. Deemed disposition every 21 years

There is a deemed disposition every 21 years after the establishment of the trust. This means that every 21 years, the assets in the trust are considered sold and any capital gains must be taxed and paid accordingly. This is to prevent deferring taxes definitely. To plan around this, usually the assets are transferred to beneficiaries before the 21 year anniversary.

2. High tax rate

The trust is taxed like an individual tax payer. Any income the trust retains is taxed at the highest marginal rate. It is generally more tax efficient to pay out proceeds of the trust to the beneficiaries, who have a progressive tax rate, and usually a lower tax rate.

3. Cost

There is significant cost in setting up and maintaining a trust.

  • Legal fees in drafting the trust agreement and setting up the trust
  • Transaction costs is transferring assets to the trust
  • Compensation for Trustee to manage assets (could be significant if the trust is large and complicated)
  • Annual tax filings
  • Additional record keeping and administrative costs

Recent changes to trusts

There have been recent changes to income that is subject to tax on split income (TOSI) that has affected the ways in which trusts can be used. The TOSI rules are fairly complicated but basically, if the income does not fall under certain exemptions, it is taxed at the highest marginal tax rate thus eliminating any tax advantage of splitting income among family members. One of the new changes requires that to qualify for the exemption, family members must directly hold at least 10% of the shares. Remember that in a trust, the Trustee directly holds the shares and the family members are only the beneficiaries.

The remaining exclusions from the highest marginal tax rate require a certain level of involvement with the business. Therefore, this change will affect beneficiaries who were never involved in the business and only took in the passive income stream from the shares or the so called “trust fund kids”.***

Conclusion

With these new changes on TOSI that affect the use of trusts for tax splitting among family members, you can expect fewer corporate structures that include a family trust to produce so called “trust fund kids”.

A family trust has some specific use cases but many of the uses of a family trust can be accomplished through holding corporations. The main advantage of a trust is the idea of indirect beneficial ownership which gives family trusts greater flexibility for certain scenarios for tax and estate planning.

If you are considering a tax and estate plan, please contact us as each case is different and the details matter in choosing the best structure.

* There are legal requirements that a trust must meet to be considered a valid trust. Failing to meet these requirements could result in a finding that the trust is invalid leading to unintended consequences.

** There is no benefit in setting up an estate freeze and subsequently selling the transferred assets; the increase in value of the asset, if any, would be small therefore the tax savings would be minimal and negated by the cost of setting up the trust. This type of transaction also assumes that the value of the asset will increase.

*** This is essentially an expansion of the “kiddie tax” rule exacted in 2000 which taxed income distributed to individuals below the age of 18 at the highest marginal tax rate.