22 October 1998 GST/HST Interpretation HQR0000589 - Subdivision of Lot and Subsequent Sale

                                                                        GST/HST Rulings and Interpretations
 Directorate
Place Vanier, Tower C, 10th Floor
25 McArthur Road
Vanier, Ontario

Dear Mr. XXXXX

Thank you for your electronic mail message of January 22, 1998 concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to the subdivision and subsequent sale of a lot. This letter is further to XXXXX response of November 25, 1996 to your earlier electronic mail messages of February 26, 1996 and March 8, 1996 on this subject.

Facts (as stated in XXXXX letter of November 25, 1996)

1. The facts provided for the existing circumstances are the following:

(a) an individual owns 100% of the shares of a corporation;

(b) the individual is not registered for the GST/HST;

(c) the corporation is registered for the GST/HST;

(d) currently, the corporation owns XXXXX of a used residential complex;

(e) the corporation claims that the used residential complex is capital property of the corporation;

(f) the corporation is currently renting the used residential complex to the individual that owns the corporation;

(g) the corporation has not charged GST on the rental of the house and has not claimed any input tax credits for any purchases relating to the house;

(h) the corporation is in the business of engineering consulting, developing real property, construction and related activities and has previously constructed one house and sold it (refer to sub-items (j) through (o) below);

(i) the individual has not previously carried out the transaction proposed below nor a similar transaction nor carried out a series of transactions involving building a house, moving in, buying another lot, building a house, moving into the new house, and so on;

(j) the corporation originally purchased XXXXX adjacent properties in XXXXX on each of which there were XXXXX houses that are XXXXX[;]

(k) the properties purchased by the corporation were XXXXX and were located in XXXXX[;]

(l) the intent of the corporation was to demolish the houses, subdivide the properties so that there were XXXXX three equally wide lots where there used to be two lots, build houses and sell the land with the new houses (with one of the houses sold to the individual who is the sole shareholder of the corporation);

(m) approval was received to have the zoning changed from a minimum frontage of 66' to 44' and for the severance and construction as intended by the corporation;

(n) both of the older houses straddled the proposed boundaries of the subdivided lots so the houses would both have to be moved or demolished for the plan to be implemented;

(o) the corporation carried out the first part of the plan by demolishing one of the older houses, completing the severance, building a new house and selling the house to a third party (the sale was completed in XXXXX[;]

(p) the second older house still exists, sitting on a lot that is XXXXX, and is the one being rented to the individual by the corporation;

(q) the proposed transactions (see item 2 of Facts, below) would complete the initial plan of the corporation by demolishing the second older house, completing the remaining severance, building new houses and selling it or selling the vacant lot;

(r) the proposed transactions would also complete the initial plan of the individual by demolishing the second older house, completing the severance and building a new house that would become the individual's principal residence;

(s) the remaining older house has three bedrooms, a living room, a family room, a dining room, a kitchen and, in the basement, a recreational room;

(t) the corporation has a small office space (for which it claims a portion of the costs of operating the house) in the existing older house (that is rented by the individual) and intends to have a similar office in the new house, yet to be built, that will be owned by the individual; and

(u) at the end of the series of transactions there will be three new houses on three lots each measuring XXXXX 44' x 165', XXXXX one occupied as a principal residence by the individual.

2. The individual proposes to cause to occur the following transactions with the corresponding conditions:

(a) the corporation will sell the individual a 50% interest in the used single unit residential complex so that each of the corporation and the individual own a XXXXX interest in a tenants-in-common relationship (not a partnership, not joint tenancy and not a joint venture);

(b) the owners (the corporation and the individual) will demolish the house because the demolition must be completed before the municipality will permit the subdivision to occur;

(c) if permitted by the municipal authorities, the owners will subdivide the lot (which would now be vacant) into XXXXX two separate lots;

(d) the two newly created lots will, for all practical purposes, be identical in size, shape, value, etc.;

(e) each of the individual and the corporation will give up their XXXXX interest in each of the tw[o] XXXXX vacant lots in return for full (100%) fee simple (i.e., legal and equitable) ownership of one of the newly created lots in a transaction or series of transactions in which no money will be exchanged;

(f) the corporation will sell its vacant lot to a third party or develop the lot for sale; and

(g) the individual will construct a residential complex on his lot for his own use.

Interpretation Requested

1. In your earlier correspondence you requested an interpretation for the following two sets of questions:

(a) Are the individual and the corporation each making a supply of real property when they give up their interest? If so, who is the recipient of these supplies and what are the tax consequences?

(b) Are the individual and the corporation each making a supply of real property when they receive one of the subdivided lots? If so, who is the supplier of these lots and what are the tax consequences?

2. XXXXX letter stated that his interpretation must consider primary and secondary issues and that the research for the secondary issues would be continuing. Part of this research would be a request for a review by Income Tax Rulings and Interpretations.

The secondary issues to which XXXXX referred included whether or not

(a) the nature of the transactions by the individual and corporation are characterized as a carrying on a business or as an adventure or concern in the nature of trade (taking into account the legislation and Policy Statement P-059) and, for whichever characterization applies, during what times periods the characterization applies;

(b) the property or properties of the corporation is or are, in fact, capital property (notwithstanding that the corporation considers the property or properties to be capital property) and for what time periods it is or they are capital property;

(c) the corporation is a builder and, if it is, at what times is the corporation a builder;

(d) the proposed supply of XXXXX interest to the individual (sub-item 2(a) of Facts) is a taxable supply or exempt supply under section 2 of Part I of Schedule V to the Excise Tax Act ("the Act") (dependent on whether the corporation is a builder);

(e) change in use rules may apply to the individual or the corporation during the set of transactions;

(f) the individual is eligible for a rebate under section 256 or 257 of the Act; and,

(g) the self-supply rules in subsection 191(1) of the Act will apply to the individual or the  corporation.

You have asked that we address those issues at this time.

3. You have also asked that we address additional questions dealing with the following scenarios:

Scenario 1:

(i) A (an individual) and B (a corporation) each own an undivided 50% interest in Lot Z.

(ii) Lot Z is subdivided to create Lots X and Y.

(iii) A gives up his 50% undivided interest in Lot Z to obtain a 50% undivided interest in Lot X and Lot Y.

(iv) B gives up its 50% undivided interest in Lot Z to obtain a 50% undivided interest in Lot X and Lot Y.

(v) A gives up his 50% undivided interest in Lot Y to B in exchange for B's 50% undivided interest in Lot X resulting in A owning 100% of Lot X.

(vi) B gives up its 50% undivided interest in Lot X to A in exchange for A's 50% undivided interest in Lot Y resulting in B owning 100% of Lot Y.

Scenario 2:

(i) A (an individual) and B (a corporation) each own an undivided 50% interest in Lot Z.

(ii) Lot Z is subdivided to create Lots X and Y.

(iii) A gives up his 50% undivided interest in Lot Z to obtain 100% ownership of Lot X.

(iv) B gives up his 50% undivided interest in Lot Z to obtain 100% ownership of Lot Y.

Questions:

(a) In Scenario 1, XXXXX has confirmed that supplies have occurred in transactions (v) and (vi), when A gives up his interest in Lot Y to obtain sole ownership of Lot X. In transactions (iii) and (iv), A and B give up their interests in Lot Z to obtain their interests in Lot X and Lot Y. XXXXX has stated that "the act of subdividing a lot is not viewed as making a supply". You would like clarification as to why this is not considered a supply keeping in mind that each person gives up an interest in real property to obtain a different interest in real property.

(a) In Scenario 2, A gives up his 50% undivided interest in Lot Z to obtain 100% ownership of Lot X (i.e. bypassing steps (iii) and (iv) in Scenario 1). Does the possibility of Scenario 2 depend on the local laws/statutes governing real property in the particular location? If this scenario is possible what are the supplies for the purposes of the Act?

Interpretations Given

1. XXXXX letter responded to the questions in item 1 of Interpretations Requested. Having reviewed comments received from the Income Tax Rulings and Interpretations Directorate (c.f. sub-item 2(a), below), however, it is our view that the supply by the individual to the corporation of his interest in one of the newly-created lots (Lot A) is an exempt supply under section 9 of Part I of Schedule V to the Act. Based on the premise that the individual's only intention was to acquire a residential lot (Lot B) upon which to construct a residence for his occupancy, it can be concluded that the individual's interest in Lot A was capital property of the individual that was not used primarily in a business of the individual. XXXXX response should be amended in that regard only.

2. Secondary issues

(a) & (b) XXXXX has provided us with comments on the facts and transactions in question. In summary, the income tax view is as follows:

(i) The acquisition of the properties did not constitute a capital transaction by the corporation. It was always the corporation's intention to end up with XXXXX [t]wo 44 foo[t] XXXXX buildings lots upon which to construct houses for resale, with the remaining lot to be sold to the individual. The activity of the corporation is on account of inventory and revenue.

(ii) The individual, however, will have acquired a capital property, based on the premise that his only intention was to acquire a residential lot upon which to construct a residence for his occupancy. This position could be reviewed in light of subsequent events; such as if he began to build a dwelling for resale.

(c) The corporation was a "builder", as defined in subsection 123(1) of the Act, with respect to the new house described in sub-item 1(o) of Facts. If the possible development of the remaining lot proposed in sub-item 2(f) of Facts includes the construction of a residential complex, then the corporation will be a builder of that complex as well. In each situation, the corporation constructed or will have constructed a residential complex at a time when it had an interest in the underlying real property.

(d) The proposed supply of the 50% interest in the existing residential complex to the individual will be exempt from tax under section 2 of Part I of Schedule V to the Act, as the corporation has not claimed an ITC with respect to any improvements to the complex acquired since the corporation purchased the properties in question. The corporation is not a builder of this residential complex, as it did not acquire its interest in the real property until after the complex was constructed and the complex had been previously occupied (in sub-item 2(a) of Facts it is described as "used").

(e) The facts as presented do not indicate any change in use by the corporation during the proposed transactions. As the properties in question are considered to be inventory of the corporation (see sub-item (b) above), if at some point the corporation appropriates part or all of the properties that it owns for use as capital property, the provisions of section 196.1 of the Act will apply. The registrant will be deemed to have made a self-supply of the appropriated property. If the appropriated property is the existing single unit residential complex, there will be no tax consequences. If the appropriated property is part or all of the newly created lots (vacant or developed but, if comprising a residential complex, not used) the self-supply will be taxable with the tax being calculated on the fair market value of the property at the time of the appropriation.

Similarly, no change in use is indicated with respect to the individual in the proposed transactions. If the individual becomes a registrant and begins to use the property that he owns as capital property in commercial activities, then there will be a change in use under subsection 208(2). The individual will be deemed to have received a supply by way of sale of the property; however, as the sale will be an exempt supply under either section 2 or section 9 of Part I of Schedule V (depending upon whether or not the individual had yet constructed the proposed residential complex), no tax will be deemed to have been paid.

(f) Assuming that the individual proceeds with his intention to construct a residential complex on his lot, a rebate under section 256 of the Act may be claimed provided that all the conditions of that section are met.

A rebate under section 257 would only be available if the facts changed substantially, such that the individual would be considered to be a "builder" of the proposed residential complex, as defined in subsection 123(1) of the Act. Given the individual's present intentions, he would be considered to be constructing a residential complex other than in the course of a business or an adventure concern in the nature of trade, and thus to be excluded from the definition of "builder" by paragraph (f). Any sale of the residential complex would be exempt from tax under section 2 of Part I of Schedule V, and therefore no rebate would be available under section 257.

(g) Subsection 191(1) of the Act only applies in circumstances where the construction or substantial renovation of a single unit residential complex or residential condominium unit is substantially completed. Accordingly, the question is taken to assume that the corporation and the individual have each constructed the houses implied by sub-items 2(f) and (g) of Facts.

If the corporation gives possession of its residential complex under a lease, licence or similar arrangement entered into for residential purposes (other than an arrangement under or consequential to an agreement of purchase and sale), or under an agreement for the sale of the building and the lease of the land comprising the residential complex, then the corporation will be subject to a taxable self-supply.

Provided that the facts as indicated are correct, the occupancy by the individual of his residential complex will not give rise to a self-supply under subsection 191(1).

3. Additional questions

(a) In Scenario 1, each person is exchanging one interest in real property for a different interest in real property. This would appear on its face to fall within the definition of "supply" in subsection 123(1) of the Act, i.e. "the provision of property or a service in any manner, including sale, transfer, barter, exchange, licence, rental, lease, gift or disposition". However, after transactions (ii), (iii) and (iv) are completed, the resulting lots are owned by the same persons and to the same extent (i.e. each has an undivided 50% interest) as the original lot. In essence, although the interest may be different in terms of its legal description, each person owns the same property as before the subdivision. Therefore, in circumstances where the resulting lots are owned to the same extent by the same person or persons as the original lot, the act of subdividing a lot will not be viewed as the making of a supply.

(b) As discussed in your telephone conversation with our Doris Rist of March 27, 1998, we are unable to respond to your question regarding Scenario 2 as it is in respect of a hypothetical situation. If in the future you have been able to determine because of a specific case that this situation is in fact possible, we would be pleased to assist you further.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 952-3413.

Yours truly,

Michael Wolff
Real Property Unit
Financial Institutions & Real Property Division
GST/HST Rulings and Interpretations Directorate