Category: Domestic Tax

Executive summary

Switching to and from Airbnb or another form of short-term rentals can result in a GST/HST bill when the condo is sold or there is a change in use, the Federal Court of Appeal affirms.

Disincentivizing short-term rentals has been the policy goal of an increasing number of tax and non-tax measures. In recent years, governments at all levels have introduced stricter regulations to address housing shortages. Federally, new measures have been implemented denying short-term rental operators’ expense deductions for tax purposes in jurisdictions where such rentals are not legally permitted.

At the same time, courts have reinforced that short-term rental activity can trigger unexpected goods and services tax (GST)/harmonized sales tax (HST) obligations when the property is sold or there is a change in use, with significant financial implications for property owners.

GST/HST and short-term rentals: The legal framework

Under the Excise Tax Act, the sale of a used “residential complex” is generally exempt from GST/HST. However, a key exception applies:

If the property

a. is part of a building, that is a hotel, motel, an inn, a boarding house, a lodging house, or other similar premises; and

b. at least 10% or more of the leases or similar arrangements of the units are for periods of continuous possession or use of less than sixty days,

it may be classified as a taxable supply upon sale and not a residential complex. This means that property owners may be required to collect and remit GST/HST, potentially reducing the net proceeds from the sale or collect GST/HST from the buyer, making it less commercially appealing due to associated tax costs.

A sale for these purposes can be either a change of legal ownership, or a deemed sale when the property changes in use (e.g. from commercial to personal), albeit the legal ownership remains the same.

GST/HST collectible: 1351231 Ontario Inc. v. Canada

The Federal Court of Appeal recently affirmed the decision by the Tax Court of Canada (TCC) that GST/HST could be collected on the sale of a condo unit originally used for long-term rentals, which was later used for Airbnb.

Between February 2008 and February 2017, 1351231 Ontario Inc. owned a condominium unit which was leased on a long-term basis (i.e. the lease intervals were for 60 days or more) to third parties. The property was then listed on the Airbnb platform and rented out through a series of short-term leases until April 2018, when it was sold to a third party.

Subsequently, 1351231 Ontario Inc. was assessed for the GST/HST payable on the sale of a condominium unit citing unavailability of GST/HST exemption available on the sale of a used residential complex.

The TCC had upheld the CRA assessment determining that the property did not qualify as an exempt “residential complex” under section 2 of the Part I to Schedule V of the Excise Tax Act. At the time the condo unit was sold, it was considered to be a real property that is similar to a hotel, motel, or other similar premises, meeting the first criteria set out in the exception above.

For the second criteria, 1351231 Ontario Inc. attempted to argue the TCC had to consider the entire period of ownership, and that more than 90% of the overall rentals in that period were long-term rentals. TCC rejected this argument. It found the relevant time period to consider was at the time that the condo unit was sold. By that time, the condominium was only being leased for taxable short-term leases of less than 60 days and most being only for a few days.

On appeal, the Federal Court of Appeal affirmed the TCC’s decision.

In this case, 1351231 Ontario Inc., was registered for GST/HST. However, it is important to note that GST/HST is applicable on a taxable supply of real property, irrespective of whether the supplier is a registrant or not, for GST/HST purposes. Accordingly, the above case poses a challenge for non-registrant property owners also selling properties used for short-term rentals.

Key takeaways and challenges for property owners

This decision, alongside broader tax policy changes, has significant implications for property owners engaged in short-term rental activities, summarized below:

• Property owners selling units with substantial short-term rental history may face unexpected GST/HST liabilities, affecting their net proceeds.
• Operators in areas where short-term rentals are restricted may be unable to deduct related expenses for income tax purposes.
• The CRA is actively enforcing GST/HST rules for mixed-use properties, highlighting the need for accurate record-keeping and professional tax planning.
• There a complicated set of change-in-use rules which may trigger GST/HST liability even in cases where the property’s use has changed from taxable to exempt, albeit the legal ownership remains the same.

As governments continue to tighten regulations on short-term rentals and real estate continues to be a popular area for CRA audits, property owners must be proactive in assessing their tax obligations.

The Canadian Income Tax law states that taxpayers are deemed to dispose of all of their property at fair market value immediately prior to death.   This can result a significant income tax liability in the year of death.  If the estate includes shares of a small business, the lack of funds to pay this liability may make it difficult to continue the business and keep it in the family.  This deemed disposition can be deferred when assets are left to a spouse or a spousal trust, but this is only a temporary solution to the problem and does not solve the problem when the shares are transferred to the children.

The purpose of an estate freeze is to transfer the future increase in the value of assets to other individuals.  In most cases, this would be other family members but could also include a key employee of the family business.  The transferor retains the current value of his/her shares and defers the income taxes on the capital gain to the time of their actual or deemed disposition.

By entering into a freeze transaction, the transferor can determine the taxes that will be due on his/her death.  Knowing what the future liability will be makes it easier to plan.  For example, a life insurance policy may be considered as an option to fund the liability.

To accomplish the estate freeze an owner of a small business corporation exchanges his/her common shares for fixed value preference shares with dividend rights.  New common shares are then issued to the new shareholders.  They will enjoy the benefits of the future growth of the business. This will result in a lower capital gain on the deemed disposition when the transferor dies. One of the reasons for a freeze is to transfer the business to the next generation.  However, consideration must be given to the share structure to allow the transferor to retain control of the business and, if he/she wants, provide a source of income by paying dividends on his/her freeze shares.

Careful consideration must be given to the value of the shares of the corporation that is being frozen.  In many cases, it is recommended that a Chartered Business Valuator be engaged to determine the value of the shares.  Unwanted tax consequences could result if the Canada Revenue Agency successfully challenges that the value of the fixed value preference shares does not line up with the value of the corporation at the time of the freeze.

What should be done if you as the business owner want to enter into an estate freeze but you are not sure whom you want the future growth to go to or your children are too young to have share ownership?  In this situation, it would be a great idea to create a family trust to hold the new common shares.  A family trust allows you to put off this decision for up to twenty-one years.  Beneficiaries of the trust normally include all family members.  At some date in the future, the trustees of the trust give the shares to the chosen beneficiaries.  This is a non-taxable event.  To provide for maximum flexibility, the business owner would also be a beneficiary of the trust in the event he/she decides not to transfer future growth and effectively decides to cancel the freeze. In certain circumstances income splitting can be achieved by paying dividends to the trust and then allocating the funds to beneficiaries. It is recommended that you seek professional advice before undertaking such tax planning and to help with the creation of a family trust.

Often the freeze shares that the transferor receives are redeemed over a number of years as part of their retirement income.  This spreads out the tax liability and reduces the liability to their estate.

Individuals who have a significant portfolio of investments may want to consider implementing an estate freeze.  To do so they would incorporate a holding company in which to transfer the portfolio.  At the end of the transactions, the individual will own fixed value preference shares of the holding company and possibly a note receivable from the holding company with a combined value equal to the value of the stock portfolio.  Other family members or a family trust will hold the common shares.  Careful planning is required, including proper tax filings in order to transfer the portfolio to the holding company on a tax-deferred basis.  In addition, the transferor needs to be aware of and to plan around the corporate attribution rules of the Income Tax Act, which could have a negative effect on the planning for years into the future.

In summary, an estate freeze can be a very good tax-planning tool but there are a number of items that must be addressed and considered before undertaking such a plan.  A bad plan could result in an unwanted tax bill.   The plan should be tailored to fit your needs. 

A September 6, 2024, Tax Court of Canada case reviewed whether a taxpayer’s employment by a corporation owned by her brother was insurable. The taxpayer performed various office duties for the corporation.

As the taxpayer was related to the corporation, she was non-arm’s length to the employer. A nonarm’s length employee is engaged in insurable employment if it is reasonable to conclude that they would have entered into a substantially similar employment contract with an arm’s length person. Some aspects commonly relevant to such determinations are remuneration paid, duration of work performed, nature and importance of work and, terms and conditions of employment.

Earnings not insurable

The Court stated that the taxpayer’s evidence was not credible and concluded that her employment was discretionary (that is not substantially similar to a contract with an arm’s length person) and not insurable, supported by the following facts:

• at various times, the taxpayer indicated that she was paid based on salary, hourly wages or both at the same time;
• the taxpayer was unable to explain how the insurable earnings reported on her Records of Employment were computed, and they were not consistent with her testimony on how her compensation was determined;
• the evidence provided indicated that her employment was sporadic, with layoffs at various times of the year (in a period of just over five years, the taxpayer was laid off at least once during each calendar month); and
• the taxpayer’s vacation in each year varied from 2 to 33 weeks.

The Court concluded that similar terms would not have been available to an arm’s length employee, so the employment was not insurable.

As the earnings were not insurable, the employee and employer would not be responsible for EI premiums; however, the employee would not be eligible to receive EI benefits (such as sickness benefits, caregiving benefits, maternity or parental benefits, or regular benefits).

If an employee is a relative of the business owner, confirm whether their income is insurable or not, as this affects EI premiums and benefit eligibility.

There are several reasons an individual might convert part of their home into a rental property. However, this action can have significant income tax implications, including potentially limiting access to the principal residence exemption, which can be easily overlooked.

Two June 27, 2024, Technical Interpretations analyzed the tax implications of creating secondary suites. The suites reviewed in one interpretation were eligible for provincial program that provided forgivable loans, while the suite in the other interpretation qualified for the multigenerational home renovation tax credit.

Provincial program – forgivable loan

The program (BC Secondary suite incentive program) offers a forgivable loan to homeowners who create a new secondary suite or accessory dwelling unit on the property of their principal residence. For this particular program, the loan would be forgivable if the suite is rented at below-market rates for at least five years. The secondary suite must be a newly constructed legal self-contained unit and could include secondary suites attached to the primary residence (e.g. basement suites) or detached secondary suites (e.g. laneway homes and garden suites). Participants must enter into a rental agreement with a tenant who is not an immediate family member. Similar programs may be offered in other provinces and jurisdictions.

Source of income

CRA opined that the rent received would likely be a source of property income. The actual rent would be reported and not adjusted to fair market value. CRA noted that it was possible, depending on all facts and circumstances, that the activity would not be a source of income, in which case any losses would not be deductible.

Treatment of forgivable loan

The forgivable loan would generally be government assistance and result in a reduction of the cost of the secondary suite.

Change of use

CRA noted that a taxpayer who has partially converted their principal residence to an income-producing use would be deemed to dispose of (and reacquire) that part of the property for proceeds equal to its proportionate share of the property’s fair market value. Any resulting capital gain may be eliminated or reduced by the principal residence exemption.

CRA referred to their policy not to apply the deemed disposition provision in certain cases where a principal residence is also used to generate income but opined that the creation of a second housing unit as required for the provincial program would be a structural change, and therefore the deemed disposition provision would apply.

CRA confirmed that an election to avoid the deemed disposition could be filed. In this case, the deemed disposition would be avoided; however, CCA could not be claimed against the rental income.

Multigenerational home renovation tax credit (MHRTC)

The MHRTC provides tax credits for homeowners who renovate their homes to create a secondary unit for a qualifying individual (a senior or an adult eligible for the disability tax credit). The secondary unit must be self-contained with a private entrance, kitchen, bathroom, and sleeping area and must meet local standards to qualify as a secondary unit.

Change of use

Whether a deemed disposition occurs upon partial change in use is a question of fact. Since the MHRTC does not require the secondary unit to generate rental income, and the unit would be used by a family member, there may not have been a change in use to gaining or producing income (from personal use). As such, the partial change in use rules may not apply.

Principal residence exemption (PRE) for secondary suites

Both interpretations discussed how secondary suites affect the PRE. If two units are each self-contained, each with its own entrance, kitchen and bathroom and can be ordinarily inhabited separate from each other (that is, without access to the other unit), CRA’s view is that they will generally be considered separate housing units for the PRE. Where it can be demonstrated that the two units are sufficiently integrated (both structurally and in their usage) and are being used for the exclusive use and enjoyment of the taxpayer and their family (that is, the two units are integrated to function as one single-family residence), it is possible that they would be a single housing unit.

In discussing the provincial program, CRA noted that the secondary suite would be a separate housing unit for PRE purposes. Even if it is part of the same structure or lot as the main home, only one unit could be designated as the principal residence each year. Since the suite must be rented to a non-family member to qualify for the program, it would not typically be inhabited by the homeowner, so it would likely not qualify for the PRE. However, the main residence could still qualify if it meets the usual requirements.

In the context of the MHRTC, CRA indicated that a taxpayer who constructs a secondary unit that is a self-contained housing unit eligible for the MHRTC would generally be considered to have two separate housing units. However, where the second unit is used for personal purposes and the taxpayer can demonstrate that the two units are being used together and functioning as a single unit, it may be possible to treat the property as a single unit eligible for the PRE. The determination of whether there are two self-contained housing units would be fact-dependent, as discussed above. Key factors would include the extent of the integration between the units and whether they share legal titles, mailing addresses, entrance doors and utility accounts.

Adding a secondary unit to a home may trigger a taxable disposition or limit the principal residence exemption. Assess tax implications before starting renovations.

The city of Hamilton will participate in the Vacant Unit Tax regime for 2024 (similar to Ottawa and Toronto) whereby every Hamilton residential homeowner will be required to file the declaration form. The deadline is April 30, 2025.

What Happens If I Don’t File?

Failure to file the form will result in the City considering the property to be vacant, and the Vacant Unit Tax will apply.

The Vacant Unit Tax is calculated at a rate of 1% of the property’s current assessed value and will be included in the final property tax bill that gets mailed out in June 2025.

What Are the Penalties?

If the form is not filed by the deadline, a $250 late fee will apply.

The penalty for non-payment is 1.25% immediately, plus 1.25% interest per month.

How Do I File the Form?

Please see Vacant Unit Tax | City of Hamilton for further information, as well as details on how to file the form.

For Further Assistance

For questions regarding the Vacant Unit Housing Tax or for help with completing the form, you can contact the City of Hamilton by phone at 905-546-2573 or by email at VacantUnitTax@hamilton.ca.