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Q: Could you explain how Assignments are taxed (other than the HST rebate – dealt with in previous post)?
So… you have just gotten the news that you are quarantined, that school is shut down for 4 weeks and you don’t have child care, that you are running perilously low on toilet paper and that your American cousin has, overnight become an immunology expert due to something he watched on Fox news? Only one sure way to put a smile on your face now guys, tax law! Given that I am continuing to get a lot of DM’s asking me questions about the post I made on the HST rebate (keep them coming, or better yet, post them so everyone can see), I may as well address how the taxation of assignments work in the normal course.
For the purpose of this post, I am going to use the following hypothetical figures which I am attributing to the blank sections of Schedule “B” to the OREA 145/150 agreements. For your own reference and to help you follow along, I am attaching Schedule “B” to this post so that you can quickly reference what I am talking about if you are new to the assignment agreement:
Let’s fill out a hypothetical mathematical scenario together.
Schedule “B” Filled Out*
1) Total Purchase Price including Original APS and Assignment Profit: $600,000.00
2) Purchase Price of the Original APS: $470,000.00
3) Deposits Paid by the Assignor to the Seller under the Original APS: $80,000.00
4) Payment by Assignee to Assignor for this Assignment Agreement: $210,000.00
5) Deposits Paid Under this Assignment Agreement: $40,000.00
6) Balance of Payment for this Assignment Agreement: $170,000.00
*Before I get to the tax portion of this post, please note how we came up with these numbers as the math of schedule “B” is ROUTINELY confused by agents. The calculation above is as follows: Line 1 (minus) Line 2 (plus) Line 3 (equals) Line 4 (minus) Line 5 (equals) Line 6.
Taxes
So… to the tax. First, let’s note that tax is always payable on an assignment. The one thing that makes real estate tax free on sale, the principle residence exemption, is not available in an assignment situation as the property has, by definition, never been resided in.
In the normal course of things, sold items can be subject to three types of taxes. Income Taxes, Capital Gains Taxes and Sales Taxes. Let’s talk about how all three of those taxes work.
A) Income Taxes & Capital Gains Taxes
Income taxes are taxes paid on your regular business activities. Your paycheck, any income you earn in the normal course of your business etc. is taxed as Income at your marginal rate of tax (more on this below). Conversely and unlike normal income, Capital Gains tax is a tax on your capital investments and is taxed at half of the rate of Income.
In English, this means that, using the 2020 tax table attached to this post, if someone is in the top tax bracket of income (earns above $220,000.00 per year) then every new dollar they take in as business income will be taxed at a rate of 53.53% and every new dollar they take in as a result of capital gains will be taxed at a rate of 26.76%.
In English, this means that, using the 2020 tax table attached to this post, if someone is in the top tax bracket of income (earns above $220,000.00 per year) then every new dollar they take in as business income will be taxed at a rate of 53.53% and every new dollar they take in as a result of capital gains will be taxed at a rate of 26.76%.
B) Sales Taxes (HST)
Whenever you sell anything in Canada to an end user, with the exception of very few things (ie residential property and mortgage broker services), it is subject to retail sales tax (HST). The partially used soap on Craigslist? Used car sales? Babysitter services? HST applies. Now, I know you are all going to pipe up and tell me that you have been working your midnight candle stand / healing stone business from the back of your sister’s van for years and have never once collected tax on those sales but, before you publicly reveal yourself to the CRA, please understand that not collecting/paying tax and not have a legal obligation to collect/pay tax are very different things. Frankly, the CRA usually just lets small business transactions slide and so you magically think HST is not applicable even though it very much is. Who knew that Patty the babysitter is a crook on the run from the Feds?
The Taxes that Could be Payable
So, having established our basic tax vocabulary, let’s turn our attention back to our original question, what tax is actually payable on an assignment? Well, as you can imagine, given the consequential difference in net profit that results from classifying a sale as income v. classifying a sale as capital, this is a subject of some dispute between tax payers and the CRA. The tax payer always wants to deem the sale of an assignment a capital sale and the CRA always wants to classify it as income. If the CRA is successful, in addition to income rates of tax being levied as against the assignor, the CRA can claim that the assignor is, in fact, a “developer of the land” and that the sale of the contract means that HST is payable on the assignment profit plus, for some reason no sane person really understands, the return of the deposits paid by the assignor to the seller under the original APS. For those of you who need help with the math, check out the attached math calculation that I am uploading as part of this post.
So, to the critical question. What determines if the Assignor needs to classify this as income tax or a capital gain? Again, a basic tax lesson is necessary before continuing further.
In explaining the difference between what is subject to income tax and what is subject to capital gains, I like to use the example of a certain Apple Farm just west of Toronto. Many of you with kids will be familiar with the fall activity of apple picking and, specifically, the mad rush to pay farmers $20.00 per bag for the right to allow your children to pick pesticide laden apples (note: employees are trained to say the white powder on the apples are sprayed wax which, frankly, may mean they are eating too many of their own apples). When Mr. Farmer takes his $20.00 per bag from parents who, by that time, are willing to pay anything to just get the heck out of there, s/he needs to pay income tax on that bag of apples. After all, their primary business is selling apples to the public. Similarly, directly up the street from the Apple farm in question is a Christmas Tree farm. Like the apple farmer, the Christmas Tree farmer sells trees for $20.00 a tree and, like with the apples, has to pay income tax on the sales of those trees.
Continuing with our example, let’s say that one day the Apple Farmer decides he has had enough of partnering with Monsanto to poison young children and decides to cut down his apple orchard. He sells the trees for $1,000.00. That $1,000.00 is derived from selling the same product as his neighbour (trees) but, as the trees in question were used for capital purposes – to produce apples – the trees in this instance are a capital sale and thus, a capital gain. The apple farmer’s after-tax profit on the sale of his trees would thus be significantly more than the Christmas farmer’s sale of his trees as the sale of the apple farm trees would be taxed at half the rate of those of the Christmas trees.
So, to conclude this section, I have used a lot of words to get to this point and, more specifically, to get to this critical sentence. In tax, it is the context of the sale that matters to determine what tax is leviable.
The Actual Tax Payable
Okay, let’s bring this post to a head. What taxes are payable? Well, the CRA’s official position is that what matters is the Assignor’s intention at the time the original agreement was signed. Did the Assignor have the intention of using the unit and deriving rental income or living enjoyment from it? If so, the assignment should be taxed in a manner similar to when the apple farmer when sold their apple trees. If, by contrast, the Assignor purchased the unit and intended to make a profit from the sale of the unit through an assignment, the purchaser’s business would be similar to the sale of the apple farmer selling his/her apples and thus subject to income tax.
Of course, determining taxpayer intent at the time of purchase is the subject of tons of litigation. In general however, certain truisms do apply. First, the less you assign, the more chance you have at substantiating your claim that the assignment sale was a one off occurrence. Second, life events that can explain assignments (I moved to NYC for med school, got married and moved to England etc) can all be used as evidence in a tax trial that the assignment was not contemplated at the time the purchase was entered into.
Conclusion
As you can see from the above, it is absolutely critical that you do not give your assignor tax advice in the course of an assignment. Even if you fully understand the above information, you do not know about the Assignor’s personal circumstance nor can you guarantee how the CRA will interpret the sale. It is therefore imperative that you direct your clients to an accountant in advance of the assignment taking place who can advise the Assignor as to their particular tax exposure given their personal circumstance. Above all, beware of anyone who can tell you with certainty that they “understand assignments and all that is payable is capital gains because I have done this several times and have only had to pay that tax”.
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