If you are or your client is one of the many thousands of people who have purchased a new condo unit for the purpose of renting it out and if you or they have signed a leaseback agreement with a builder or another company, you should be aware of the potential pitfalls. All over the country developers are selling condominium units to purchasers and offering a "guaranteed rental" incentive. While a condo that comes with a two-, five- or even 10-year guaranteed rental sounds like a wise investment, it may also come with hidden costs.

The way these guaranteed rentals work is that the purchaser of the newly built condominium enters into an agreement with the builder or some other company, whereby that company rents the unit from the condo buyer for a specified period of time. That company in turn rents the units out to people who are going to occupy and live in the condo and it earns a profit from doing so. Thus the owner has "guaranteed" rental income from the company.

Paragraph 123(1) of the Excise Tax (the Act) provides a lengthy definition of a builder. Included in this definition is language that captures those purchasers who have acquired a condo for the primary purpose of renting it to another party who will not be living there but who instead has the goal of earning income from renting the condominium to others. The Act notes that the "builder of a residential complex includes a person who acquires an interest in the complex before it has been occupied by an individual as a place of residence or lodging, for the primary purpose of making one or more supplies of the complex or parts thereof by way of lease, licence or similar arrangement to persons other than to individuals who are acquiring the complex or parts otherwise than in the course of a business or an adventure or concern in the nature of trade."

Because of this provision, thousands of people across the country have started to receive letters indicating that for GST/HST purposes they meet the definition of a "builder." Also, because they meet the definition of a builder, the Canada Revenue Agency (CRA) requires that they self-assess under s. 191(1) of the Act. Being classified as a builder means that at the time of self-supply, the owner of the unit is deemed to have sold the property to themselves and GST/HST would be payable upon that sale, resulting in tens of thousands of dollars in GST/HST for many unwitting buyers.

The CRA has been sending these letters with a position that appears to be bulletproof, using wording such as "for GST/HST purposes you meet the definition of a builder as defined in Paragraph 123(1)(d) of the Excise Tax Act," rather than "we believe that you may meet the definition." In addition, although their position appears to be irrefutable under the definition of builder in the Act, part of the definition being relied upon by the CRA and being referenced above includes the language "primary purpose," which actually provides an excellent opportunity for a challenge and makes the CRA's position appear to be less ironclad.

In order to defeat the CRA and challenge their position that the taxpayer is a builder, it becomes the job of the taxpayer or their representative to demonstrate what the actual primary purpose of the condo unit is and to challenge the CRA's underlying assumptions with respect to the acquisition of it. Since the CRA doesn't typically have any evidence against the taxpayer other than a leaseback agreement, they don't really have any knowledge about the taxpayer's "primary purpose."

But don't always count on being able to win this argument without having to go to court.

Remember that within the four walls of the CRA, when you're dealing with auditors, appeals officers or, in the case of these leaseback agreements, clerks in the GST/HST Refund Integrity section, employees can use their own judgment and ignore external evidence, facts and the law. Thankfully the lawyers at the Department of Justice who represent the CRA and the judges who sit on the bench of the Tax Court of Canada, however, will be a lot more careful to look at all the evidence and won't be as likely to be persuaded by a theory or assumption.

Originally published by The Lawyer's Daily.

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