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Personal use property owned by a corporation

In my many years of practice, it never fails to amaze me how many people rely on non-qualified persons for advice in one of the most complex topics there is – tax planning or, as Moodys LLP likes to call it, “tax optimization”.  There is no shortage of “experts” who seem to think that they understand tax.  In this day and age of instant information vis-à-vis the internet, such “experts” continue to flourish and continue to dispense tax advice to their colleagues and buddies.  Unfortunately, many of those people end up in our offices seeking advice when things go wrong.  In many cases, such advice has led to “planning” which is a ticking time bomb waiting for nasty results should their affairs ever be reviewed.

One of the most common ticking time bombs that we run across is personal use property owned by a corporation.  Routinely, we find cottage properties owned by corporations.  In some extreme cases, we discover situations where the shareholder’s or shareholders’ principal residence is owned by a corporation. Such “planning” is usually disastrous.  Why is that?  Well, there are a number of reasons.  The biggest reason is that personal use property owned by a corporation will result in taxable benefits being applicable to the individual shareholder(s).  The relevant provision under the Income Tax Act that requires a taxable benefit is subsection 15(1) which reads as follows:

15(1) Benefit conferred on shareholder — Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by

(a) the reduction of the paid-up capital, the redemption, cancellation or acquisition by the corporation of shares of its capital stock or on the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 88 applies,

(b) the payment of a dividend or a stock dividend,

(c) conferring, on all owners of common shares of the capital stock of the corporation at that time, a right in respect of each common share, that is identical to every other right conferred at that time in respect of each other such share, to acquire additional shares of the capital stock of the corporation, and, for the purpose of this paragraph,

(i) where

(A) the voting rights attached to a particular class of common shares of the capital stock of a corporation differ from the voting rights attached to another class of common shares of the capital stock of the corporation, and

(B) there are no other differences between the terms and conditions of the classes of shares that could cause the fair market value of a share of the particular class to differ materially from the fair market value of a share of the other class,

the shares of the particular class shall be deemed to be property that is identical to the shares of the other class, and

(ii) rights are not considered identical if the cost of acquiring the rights differs, or

(d) an action described in paragraph 84(1)(c.1), (c.2) or (c.3),

the amount or value thereof shall, except to the extent that it is deemed by section 84 to be a dividend, be included in computing the income of the shareholder for the year. [emphasis added]

As you can see, subsection 15(1) is an extremely broad provision which can capture many fact patterns.  The difficulty with the provision is that it does not set out detailed rules on how to quantify the taxable benefit.  In the case of a cottage property, for example, many people feel that a comparable hotel rate is the appropriate taxable benefit that they need to capture into their personal taxable income or to pay to the corporation for the use of that cottage property.  For example, if Mr. and Mrs. Apple each owned 50 percent of the shares of “OpCo” and OpCo owned a cottage property in Phoenix, Arizona, would the taxable benefit be say, $200 a night (a comparable hotel rate) multiplied by the number of days that they use the property (say five days per year) which equals $1,000?  In short, the answer is no.  Instead, the Tax Court of Canada has found in cases such as Youngman [1990] 2 CTC 10 (FCA), Donovan [1996] 1 CTC 264 (FCA), and Fingold [1997] 3 CTC 441 (FCA) that the taxable benefits applicable to the ownership of a cottage property by a corporation is not the hotel rate.  Instead, the taxable benefit is generally computed by reference to the cost of the property multiplied by an applicable rate of return.  For example, if OpCo had paid $500,000 for the acquisition of the Phoenix, Arizona property and OpCo would normally receive a 15 percent rate of return on its invested capital then likely 15 percent of $500,000 (or $75,000) would be the appropriate amount to include in Mr. and Mrs. Apple’s personal taxable income annually.

If you are not already awake or did not know about the risks of personal use assets owned by a corporation, then you should be aware that there is further damage.  Firstly, there is no underlying “step-up” in the cost base of the personal use corporately owned assets for the taxable benefit received each year by Mr. and Mrs. Apple.  This can lead to outright double taxation as a result of the corporation owning the personal use property.  Secondly, when the property is sold, OpCo will realize a capital gain (assuming the property has increased in value) which may not be sheltered by any principal residence exemption (if the property could otherwise be treated as a principal residence by the individual shareholders).  Finally, to the extent that the funds need to be extracted from the corporation, such extraction will normally be considered a taxable dividend (unless other tax free accounts are available such as a shareholder loan account or a capital dividend account).  I have purposely not discussed any GST or HST matters but such issues would also need to be reviewed.

At this point, it may be prudent to let the reader know that the Canada Revenue Agency used to have an administrative position which enabled a corporation (often referred to as “sole purpose/single purpose” corporations) to acquire US personal property without subsection 15(1) applying.  However, this administrative position ended for acquisitions of US property after 2004 with some limited grandfathering.  Accordingly, people need to be very aware of the dangers of acquiring US personal use property through a corporation.  However, such a caution extends to all types of personal use property.  For example, we have often seen timeshare properties, personal furniture, recreational vehicles, etc., owned by corporations.  It appears that people think that significant tax savings can be achieved by owning such properties through a corporation.  Unfortunately, nothing could be further from the truth.

So what do you do if you have personal use property owned by a corporation and you are one of the shareholders?  Unfortunately, there are not many solutions to this difficult issue.  Instead, you should be looking to extract the personal use property from the corporation using available tax free accounts.  However, if tax free accounts are not available then simply paying the personal income tax on an extraction may be far cheaper in the short and long term to avoid nasty surprises.

For those of you who would like to see a video on this topic in Moodys’ YouTube channel, click here.