In this indirect tax insight article, we describe goods and services tax and harmonized sales tax (GST/HST) and Quebec sales tax (QST) compliance issues relating to newly constructed residential rental properties as well as commercial properties converted to residential rental properties.
Audit activity by the Canada Revenue Agency (CRA) and the Quebec Revenue Agency (QRA) is again picking up in the areas of the GST/HST and QST. For nearly a year now and at the height of the pandemic, many Canadian tax authorities ceased or greatly reduced their audit activity, unless a business was expecting a refund of GST/HST, QST or provincial sales taxes.
Currently, refunds are still getting priority for a variety of reasons. However, these indirect tax authorities are taking a much closer look before releasing these refunds, than they were over the last 10 months. As such, it may be worthwhile to review potential GST/HST and QST compliance issues that could arise in the course of an audit by CRA or QRA.
Implementing processes to correct potential compliance issues in advance of an audit are always preferred to resolving proposed assessments of tax and the application of interest and penalties. Also, an extended and sometimes more in-depth audit or enquiry may result when significant issues and errors are identified.
For brevity, references to GST/HST and the CRA should be considered synonymous with references to the QST and QRA respectively, as the legislation and the CRA’s and QRA’s administrative policies are generally harmonized.
Residential rental property
In general, long-term residential rentals1, including apartments, condominiums and seniors’ housing, are exempt from GST/HST. As a result, GST/HST does not apply to the rental revenues, but the landlord has no ability to recover these taxes by way of input tax credit (ITC) on the acquisition of taxable inputs for exempt residential rental purposes.
Special rules, generally referred to as the “self-supply” rules, apply to the construction of new residential rental property as well as substantial renovations and additions to existing residential properties. Also, the self-supply rules may apply to new homes built for sale that are converted to long term residential rentals and to conversions of various commercial properties such as office buildings and hotels to long term residential rental properties.
The self-supply rules for residential rental properties may be described in terms of three stages:
1. Acquisition, development, construction
This is the commercial activity phase. ITCs are available to recover GST/HST on the acquisition of the land and taxable development and construction costs.
At the later of substantial completion and first occupancy by a tenant as a place of residence, the builder remits GST/HST on the fair market value (FMV) of the residential rental property. The builder may be entitled to the landlord rebate.
The ongoing operation of the residential rental property is an exempt activity. GST/HST does not apply to rental revenue and the GST/HST on taxable costs is not recoverable by way of ITC.
Practically speaking, builders should register for GST/HST prior to the initial planning and design stage or the real estate purchase, so that they can claim ITCs for the GST/HST incurred on all eligible inputs. Upon the self-supply event, the builder is then required to calculate and remit the GST/HST on the FMV of the residential rental property at the later of the time of substantial completion or first occupancy by a tenant (i.e., timing of the self-supply).2
Importantly, ITCs cannot generally be claimed on costs relating to the completion of construction or improvements to the residential rental property following the time of the self-supply. The GST/HST paid on operating costs of exempt residential properties are also not recoverable by way of ITC claims. However, residential rental property rebates (or landlord rebate) may be available to the builder to recover a portion of the GST/HST that is payable on the self-supply.
These self-supply rules and especially the FMV determination and related computations can be complicated to apply in practice. The application of these rules should be planned well in advance in order to ensure that cash flow is available for significant remittances at the time of the self-supply.
Issues to consider
“Self-supply” of residential rental properties
The following are key compliance issues that clients see regularly relating to the self-supply rule:
Determination of the FMV
This is a key consideration for CRA and is routinely reviewed closely and often adjusted upward by CRA’s real estate appraisals unit. We recommend engaging an independent professional appraiser that is very familiar with the CRA’s valuation methodologies and related issues in a GST/HST context and able to defend their valuation reports should they be challenged by the CRA.
The FMV should not be based on municipal property tax assessments or unsupported sources, given that CRA routinely challenges most self-supply remittances based on the FMV reported. A valuation or calculation misstep on reporting the GST/HST payable can result in a significant assessment with the resulting impact on budgets and bottom lines.
Apartments versus condominiums
The approach to valuation and the timing of the self-supply differ for apartment buildings versus condominiums. Apartment buildings and similar properties (typically on a single title) are subject to the self-supply rule on the entire newly constructed or substantially renovated building at the later of substantial completion (generally 90%) or the first occupancy of a unit in the complex by a tenant as a place of residence.
Alternatively, the timing and valuation rules for condominiums apply on a condominium-by-condominium basis. The unique challenges for valuation and timing differences can significantly affect cash flow and there is often disputes between CRA’s approach to value versus that of independent professional appraisers. This incompatibility issue is the subject of several historical court cases as well as a pending Tax Court of Canada case.
Conversions of new sale home inventory and other commercial properties to residential
The self-supply rules apply to new single-family homes as well as condominiums, town/row-homes, etc. that are originally built for sale that, but for various reasons, are converted to long-term residential rentals. In addition, the rules will apply to commercial properties, such as older office buildings, industrial properties and motels/hotels converted to long-term residential rental properties.
The self-supply rules can also apply where there is a supply of a new residential property by way of lease, license or similar arrangement, and the agreement does not constitute a sale of the new property. Consequently, in the case of conversions of single-family homes and condominiums in particular, it is necessary to distinguish between rent-to-own agreements that may actually be sales versus rentals.
The former are subject to the general rules relating to taxable sales of new homes, including the potential for a new home rebate. However, the latter are subject to the self-supply rules that may be eligible for the builder-landlord rebate. If the tenant eventually purchases the property however, an exempt sale can occur. The GST/HST treatment can vary depending on how the rent-to-own agreement is structured. We recommend that these agreements be reviewed for GST/HST purposes.
Seniors’ residences and other special purpose properties
The “self-supply” rules generally apply to newly-constructed special purpose complexes that can include subsidized rental housing, long-term care homes or “age-in-place” projects. In addition, there has been a significant increase in conversions of commercial properties (e.g. former motels or fit-to-purpose office buildings) to special purpose housing for disadvantaged individuals in our communities. Unique GST/HST issues can arise in these circumstances, including:
- Special valuation threshold when calculating the FMV for certain government-subsidized properties
- Exclusions from the landlord rebate for public sector body organizations entitled to public sector body rebates;
- Exclusions from the self-supply rules for student residences, religious community housing and remote work sites in certain circumstances.
New residential rental property rebate (the Landlord Rebate)
Once the self-supply event occurs and GST/HST is reported, the Landlord Rebate may be creditable and offset against the self-supply GST/HST payable. However, clients have experienced numerous challenges with the rebate, including some compliance traps as follows:
Place of residence
The property has to be rented as a place of residence of an individual to be eligible for the Landlord Rebate. If the tenant is using the property for a commercial purpose, such as for short-term transient rentals, this could result in the denial of the rebate.
In general, it must be reasonably expected by the builder-landlord that the tenant or a relation of the tenant will use the unit for a period of at least one year. This can present challenges for the landlord when the lease term is less than a year, such as a month-to-month term, unless these terms total to one year.
Is there an intent to sell the property?
Demonstrating the builder-landlord’s intent can cause GST/HST audit issues if the builder-landlord enters into an agreement to sell the rental property within one year of GST/HST applying under the self-supply rule. The timing of the sale of the property should account for possible implications for the Landlord Rebate eligibility.
Is the rental unit a self-contained residence?
The Landlord Rebate can only be claimed in respect to units that meet the definition of a “self-contained residence”. A suite in a hotel, a motel/hotel or inn, a boarding house or a lodging house or in a residence for students, seniors, individuals with a disability or other individuals would meet this definition. Otherwise, the unit must contain private kitchen facilities, a private bath and a private living area to meet the rebate eligibility requirement as a self-contained residence.
How RSM can help
The real estate sector is an area where CRA auditors are very active. Our indirect tax professionals can assist companies by proactively conducting GST/HST diagnostic reviews. These reviews are intended to identify significant compliance issues and recommendations. In addition, the reviews are intended to identify potential recovery of past GST/HST overpayments or missed ITCs, s and rebates as well as opportunities to reduce future GST/HST related costs. Additionally, we can advise on proposed transactions, organization changes and participate in due diligence reviews.
Our approach is integrated and collaborative, working with our colleagues in assurance and income tax to ensure our conclusions and recommendations take into account other accounting, systems and tax issues.
If you are contacted by CRA or QRA for audit, contact our professionals today for guidance on best practices for managing the audit, assisting directly in responding to the auditor’s questions, working on dispute resolution, and responding to proposed assessments and notices of assessment.
1 Generally if the term of the rental is for more than a month.
2 The original tax policy intent of these rules is to put the builder-landlord in the same GST/HST position as if the builder had purchased the newly constructed building and related land from a third-party and paid the applicable GST/HST at the time of purchase and was not able to recover the GST/HST paid.