The Canada Revenue Agency (CRA) is always looking to ensure that shareholders who receive benefits from a corporation are taxed thereon. For instance, when a shareholder appropriates corporate assets for the shareholder’s personal purposes and does not include the value of the benefit in income, the CRA may seek to apply subsection 15(1) of the Income Tax Act (ITA). This rule provides that, when a shareholder receives a direct or indirect benefit from a corporation, the value of such benefit will be added to the shareholder’s income in the year.
Recently, in Valerie Wise v. The Queen, the Tax Court of Canada (TCC) considered the application of subsection 15(1) to the potential benefit Valerie Wise may have received qua shareholder when her corporation completed improvements to a property she owned. Specifically, the corporation rented the property from Ms. Wise and used the property as its primary business location both before and after the improvements. The TCC held that, although Ms. Wise may eventually receive a benefit from the improvements when the property reverts to her upon expiration of the lease, the value of the benefit was presently too uncertain and, therefore, subsection 15(1) did not apply (at least, not yet). The key fact on which the TCC based its decision was that the corporation had a long-term lease to use the property that included an option for a five-year extension. A fact of secondary importance was that the corporation had a clear business purpose for completing the improvements to the property.
The facts were not in dispute. In September 2008, Ms. Wise purchased a two-story building that had been built in 1920. Ms. Wise renovated the upper floor and eventually occupied the upper floor as her primary residence. Between 2008 and 2010, Ms. Wise rented the main floor to an arm’s-length party. In 2010, Wise Victoria Mortgages Inc. (WVM), a corporation that Ms. Wise and her son owned, relocated its business premises to the main floor of the property. Ms. Wise and WVM signed a lease agreement that had the following key terms:
- A five-year term with an option for WVM to extend the lease for a second five-year term;
- WVM would pay monthly rent of $2,200 plus electricity; and
- WVM could make alterations, additions or improvements to the main floor with Ms. Wise’s consent but at WVM’s sole expense.
In 2011 and 2012, WVM completed significant improvements to the main floor of the property. In particular, it incurred $457,663 of expenses in the 2011 taxation year and $164,005 in the 2012 taxation year to improve the main floor. WVM’s business benefitted from the improvements in that WVM transformed the main floor into an impressive office to attract new clients. The TCC found that WVM’s business would continue to benefit from the improvements provided that WVM maintained its principal office on the main floor of the property. WVM capitalized these expenses as ‘leasehold improvements’ and claimed capital cost allowance. WVM continued to pay $2,200 per month plus electricity notwithstanding the improvements. In 2015, WVM exercised the option to extend the lease agreement for a second five-year term.
Value of shareholder benefit
The CRA added the cost of the improvements to Ms. Wise’s income as shareholder benefits in the 2011 and 2012 taxation years under subsection 15(1) of the ITA: $457,663 in 2011 and $164,005 in 2012. The issue before the TCC was whether Ms. Wise received benefits equal to the cost of the improvements to the main floor.
The language of subsection 15(1) of the ITA is extremely broad because the purpose is to capture any benefit that a shareholder extracts from a corporation. However, one of the essential requirements for subsection 15(1) to apply is that the TCC must be able to identify the value of the benefit. Where a corporation leases property from the corporation’s shareholder and the corporation completes leasehold improvements to the property, the value of the benefit the shareholder receives is equal to the increase in value of the shareholder’s reversionary interest in the property. Put another way, the value of the benefit is equal to (1) the value of the shareholder’s reversionary interest in the improved property minus (2) the value of what the shareholder’s reversionary interest would have been without the improvements to the property.
A reversionary interest refers to ‘a right to the future enjoyment of the property’. Essentially, the value of the reversionary interest of the improved property will equal the value of the property at the time the property reverts back to the shareholder.
In Wise, the TCC held that it could not determine the value of the reversionary interest in the property because WVM had a long-term lease and, as a result, it was uncertain when the property would revert to Ms. Wise. Without being able to determine the value of Ms. Wise’s reversionary interest, the TCC held that it could not quantify the benefit until the property actually reverted to Ms. Wise. The TCC analysis revealed that, if Ms. Wise and WVM had a month-to-month lease agreement rather than a long-term lease agreement (or if WVM did not have a business purpose for completing the improvements), the TCC likely would have valued Ms. Wise’s benefit as being equal to the cost of the improvements to the main floor. The critical fact in this case was the existence of the long-term lease (including WVM’s option to extend the lease) because it prevented the TCC from being able to value Ms. Wise’s reversionary interest.
Value of any benefit must be clear
Shareholder appropriations of corporate property remain an area of CRA’s focus. The TCC’s reasons in Wise can assist taxpayers in defining the scope of acceptable planning: where (1) a shareholder leases property to his/her corporation and (2) the corporation makes improvements to the property for the corporation’s benefit, the shareholder can avoid or defer a subsection 15(1) assessment provided the lease agreement is a long-term lease.