Santagapita et al. v. The Queen, 2009 DTC 1019 (T.C.C.)
Subsection 18(3.1) of the Income Tax Act (Canada) (the "Act") denies a deduction for so-called "soft costs" incurred by a taxpayer that are attributable to the period of the construction, renovation, or alteration of a building. Such costs must be added to the capital cost of the building, which essentially postpones the ability to deduct construction period soft costs to the post-construction period in the form of capital cost allowance.
The recent decision of the Tax Court of Canada in Santagapita et al. v. The Queen, 2009 DTC 1019 (T.C.C.), considered a number of elements pertaining to the application of the soft cost capitalization rule in subsection 18(3.1) of the Act. In Santagapita, the taxpayers leased a commercial rental building owned by them to a corporation that was wholly owned by them. The building was extensively damaged by fire and the business being carried on in the building was discontinued. The taxpayers received fire insurance proceeds for loss of rent. The taxpayers made extensive repairs and renovations to the building and, on completion, the building was rented to an arm's length tenant.
The taxpayers were assessed by the Minister of National Revenue. Among other things, the Minister added the fire insurance proceeds of $50,000 on account of loss of rent to the taxpayers' income under subsection 9(1) of the Act. The Minister also capitalized all construction-related expenses incurred with respect to the renovation of the building (including mortgage interest) to the cost of the building, pursuant to subsection 18(3.1) of the Act.
The Court had no difficulty in concluding that the insurance proceeds for loss of rent were properly included in the taxpayers' income. The Court then turned to the question of when the renovation of the building was completed. The answer to this question would determine the amount of the renovation "soft costs" that would be required to be added to the cost of the building pursuant to subsection 18(3.1). The Court concluded that the renovation of the building was completed at the time the front entrance to the building was finished, as the building then became habitable and all of the planned renovation work was actually completed.
Interestingly, the Court concluded that interest expense incurred by the taxpayers on the mortgage that was taken out to acquire the property could be deducted on a current basis under paragraph 20(1)(c). The interest expense was not subject to the capitalization rule in subsection 18(3.1) of the Act, since the actual use of the mortgage proceeds related to the acquisition of the property, and not to the subsequent renovation of the building. The Court also considered the effect of subsection 20(29) of the Act. When a building is under construction or renovation and is also used to earn rental income during the construction/renovation period, subsection 20(29) of the Act permits soft costs, which would otherwise have to be capitalized, to be deducted to the extent of construction period rental income. In this case, the Court reduced the amount of the costs required to be capitalized to the building by the amount of the fire insurance proceeds received by the taxpayers on account of damages for loss of rent.
-Ian V. MacInnis, Fogler, Rubinoff LLP (Barristers & Solicitors)
Soft Costs Deductible Against Insurance Proceeds
The taxpayers leased a commercial rental building owned by them (the "Building") to a corporation wholly owned by them (the "Corporation"). Following a fire in 2001 that caused extensive damage, the business being carried on in the Building was discontinued, fire insurance proceeds of $50,000 for loss of rent were received by the Corporation in a lump sum in 2002, and the Building was extensively repaired and renovated. The Building was then rented to an arm's length tenant in 2005. In reassessing the taxpayers for 2002 and 2003, the Minister: (a) divided the $50,000 insurance proceeds into four $12,500 portions, and included $12,500 in each of the taxpayer's incomes for each of 2002 and 2003; (b) capitalized all construction-related expenses incurred with respect to the Building (including mortgage interest) up to October 29, 2003 under s. 18(3.1) of the Income Tax Act (the "Act") on the assumption that the renovations to the Building were completed at that time, and not in 2001 as the taxpayers had contended; and (c) disallowed the deduction of certain expenses under s. 18(1)(a) of the Act. The taxpayers appealed to the Tax Court of Canada.
The taxpayers' appeals were allowed in part. The $50,000 insurance proceeds were to compensate the taxpayers' for their claim for damages for loss of rent. It therefore had to be included in their income under s. 9(1) of the Act. It was also irrelevant that the $50,000 was paid to the Corporation, because the taxpayers, and not the Corporation, were entitled to receive it. However, the Minister should have included the entire $50,000 in the taxpayers' incomes for 2002 when it was received, rather than dividing it between 2002 and 2003. Therefore, no portion of the $50,000 should have been included in the taxpayers' incomes for 2003. The renovation of the Building was completed no earlier than October 29, 2003, as the Minister had assumed. But because the $50,000 constituted "income from renting the building" within the meaning of s. 20(29) of the Act, the pre-October 29, 2003 expenses that were capitalized by the Minister became deductible by the taxpayers under s. 20(29) up to the amount of the $12,500 inclusion in each of their incomes for 2002. Conversely, the mortgage interest was unaffected by the capitalization rules in s. 18(3.1) of the Act, since the mortgage proceeds were used by the taxpayers to purchase the Building, and not to renovate it. Hence, the taxpayers were entitled under s. 20(1)(c) to deduct mortgage interest on a current basis. For 2002 and 2003, these deductions amounted to one-half of $19,044 and $19,218, respectively, for each taxpayer. The evidence also indicated that utilities expenses of $1,502 were incurred during 2002, but that no amounts in excess of those permitted as deductions by the Minister were incurred by the taxpayers with respect to maintenance and repairs of the Building. The Minister was ordered to reassess accordingly.
Santagapita et al. v. The Queen,¶30-555; ¶50-480; ¶50-930; ¶50-935
Triplex Used as Residence—Taxpayers Not Entitled to Rebate
The taxpayers constructed a triplex, and occupied 48% of the available space in the triplex themselves. The parents of one of the taxpayers occupied 22% of the space in the triplex, and the balance of the space was rented to a third party. On the assumption that the taxpayers and persons not at arm's length with them were occupying the triplex primarily as a residence, the Minister concluded that the taxpayers were not liable for tax under the self-supply rules in s. 191(3) of the Excise Tax Act (the "Act"), since they fell within the exception to those rules in s. 191(5)(b) of the Act. Having thus produced a zero tax assessment under the self-supply rules, the Minister denied the taxpayers the rebate in respect of land and building for residential rental accommodation claimed by them under s. 256.2(3) of the Act. The taxpayers appealed to the Tax Court of Canada.
The taxpayers' appeals were dismissed. The issue was whether the taxpayers were using the triplex "primarily as a place of residence for the individual, an individual related to the individual or a former spouse or common-law partner of the individual" within the meaning of s. 191)(5)(b) of the Act. "Primarily" in this context means more than 50% (see Foote v. The Queen, 2007 GTC 704 (T.C.C.)). Also, in its context the word "or" in s. 191(5)(b) should be interpreted conjunctively rather than disjunctively. Logically, therefore, Parliament's intention was that s. 191(5)(b) be interpreted to cover the primary use of the complex as a place of residence for the individual and any individual related to him/her. Parliament never intended s. 191(5)(b) to extend to a situation involving the primary use of the complex as a residence for either the individual or an individual related to him/her. In the present case, the triplex was being used by the taxpayers and the parents of one of them. This brought their situation within s. 191(5)(b) and disentitled them to the s. 256.2(3) rebate claimed. This result was not an unjust one for the taxpayers, since they had never paid any GST under the self-supply rules from the outset. The Minister's assessments were affirmed accordingly.
If you found value in this material please learn more about Dustin T. Serviss @ www.serviss.ca
No comments:
Post a Comment