18 June 2003 GST/HST Ruling 37709 - Severance

Dear XXXXX:

This is in reply to your letter XXXXX concerning the Goods and Services Tax ("GST") treatment of a sale of real property by your client, XXXXX ("B"), to XXXXX ("W"). We apologize for the delay in responding.

All references are to the Excise Tax Act ("ETA").

The following facts are based on your letter and on information imparted in our various telephone conversations and your corresponding written submissions XXXXX.

Statement of Facts

1. B owned property legally described as XXXXX (hereafter the "Property"). The Property consisted of a total of XXXXX acres of land and included a residential complex (the "Complex") which B used as XXXXX principal residence.

2. B decided to sell the Property but first wished to create and retain XXXXX building lots. B thus proposed to subdivide the Property into 3 parts: a parcel containing the Complex and XXXXX acres of land (the "Residence Parcel") and XXXXX separate building lots consisting of XXXXX acres (the "Building Lots").

3. B engaged XXXXX XXXXX to submit XXXXX an application to XXXXX (the "City") to subdivide the Property in the above-described manner.

4. Before the proposed subdivision could be approved, W made an offer to purchase the Property. XXXXX B and W entered into an agreement for the purchase and sale of the Property (the "Agreement").

5. The Agreement was structured to allow B to retain the Building Lots and W to acquire the Residence Parcel. In an addendum to the Agreement XXXXX the parties agreed to the following.

•   W would execute and B would receive a Transfer/Deed of Land for the Building Lots upon approval by the City of the proposed subdivision.

•   Upon receiving approval of the proposed subdivision, W's mortgage lender would provide B with a registerable partial discharge of mortgage in respect of the Building Lots.

•   B would be entitled to register notice of the Agreement on title to the Property.

•   B would release any right, title or interest in the Residence Parcel upon approval of the proposed subdivision.

•   In the event that approval for subdivision was not obtained XXXXX, W would retain the entire Property. In that event, B would provide W with an agreement releasing any right, title or interest in the Property.

6. Approval for the proposed subdivision was imminent; as such, it was unlikely that W would retain anything more than the Residence Parcel. Consideration for the Property was therefore set at XXXXX, the estimated market value of the Residence Parcel. Upon approval of the proposed subdivision, the parties further agreed that the Building Lots would be transferred to B for consideration of $XXXXX.

7. XXXXX the sale of Property was completed.

8. XXXXX legal title to the Property transferred to W. On the same day, B made an application to register the Agreement XXXXX. In the application, B declares XXXXX to be a registered owner of the Property. Although legal title to the Property appears to have been held by W at that time, you confirmed that B retained an equitable interest therein.

9. The parties undertook to complete the proposed subdivision and retained XXXXX to submit the application on their behalf. We assume that the parties had the right to sever or subdivide the Property subject to the City's approval.

10. XXXXX the City approved the proposed subdivision. B paid all expenses relating to the subdivision.

11. W executed the appropriate Transfer/Deeds thus conveying the Building Lots to B. Legal title to the Building Lots were transferred to B XXXXX for nil consideration.

12. At all relevant times, B and W held the Property for personal use. With the exception of the subject transactions, neither party was engaged in any activities relating to real property. Further, neither B nor W claimed an input tax credit ("ITC") in respect of the Property as neither of them were registrants.

13. B and W are not related to each other for purposes of the Income Tax Act. Moreover, all of the above transactions were performed at arm's length for GST purposes.

14. Subsequent to receiving title to the Building Lots, B sold them to arm's length parties XXXXX.

Ruling Requested

You wish to know whether the ultimate sales of the Building Lots by B were taxable.

Ruling Given

Based on the facts as stated, we rule that the ultimate sales of the Building Lots by B were taxable supplies.

This ruling is subject to the general limitations and qualifications outlined in section 1.4 of Chapter 1 of the GST/HST Memoranda Series. We are bound by this ruling provided that none of the above issues is currently under audit, objection, or appeal; that there are no relevant changes in the future to the ETA or to our interpretative policy; and that you have fully described all necessary facts and transactions for which you requested a ruling.

Analysis

A number of transfers in respect of the Property (and parts thereof) occurred in order to enable W to acquire the Residence Parcel and B to retain the Building Lots. The GST consequences of each of these transfers are considered below, followed by an explanation of the GST treatment of the ultimate sale of the Building Lots by B.

Sale of the Property to W

Sales of real property made in Canada are generally taxable pursuant to section 165 unless a specific provision applies to exempt them.

Section 2 of Part I of Schedule V exempts the sale of a residential complex or an interest therein by a person who is not the builder of the complex, unless the person claimed an ITC in respect of the last acquisition of or an improvement to the complex. Since the Complex was used by B solely as a place of residence, XXXXX would not be considered to be a "builder" (Paragraph (f) of the definition of "builder" (section 123(1) of the ETA) excludes an individual who acquires a residential complex or interest therein otherwise than in the course of a business or an adventure or concern in the nature of trade.) for purposes of the ETA. Since XXXXX did not claim ITCs in respect of the Complex, the sale of the Complex to W was an exempt supply pursuant to section 2 above.

In determining the tax status of the sale to W of the entire Property (which includes the Complex), the normal procedure would be to first determine whether all or part of the Property formed part of the Complex (The ETA defines a "residential complex" to include both the building and the land immediately contiguous to the building that is reasonably necessary for the use and enjoyment of the building as a place of residence for individuals. The determination of the amount of land reasonably necessary for this purpose is the subject of CCRA policy statement P-069, Land Allowance For Residential Complexes.). If all of the land included in the Property were found to form part of the Complex, then the whole of the Property would have been exempted by section 2.

On the other hand, if only a portion of the land included in the Property were found to form part of the Complex, then the sale of the Property to W would have been subject to subsection 136(2). Under this provision, if a supply of real property includes a residential complex and other real property which is not part of a residential complex, the supply of the complex is deemed to be a separate supply from the other real property and neither supply is incidental to the other. In such a situation, the Complex would have remained exempt under section 2 above; however, the tax status of the remainder of the Property would have been subject to the exemption contained in section 9 of Part I of Schedule V. Section 9 states, in part:

A supply of real property made by way of sale by an individual or a personal trust [is exempt], other than

(a) a supply of real property that is, immediately before the time ownership or possession of the property is transferred to the recipient of the supply under the agreement for the supply, capital property used primarily ... in a business carried on by the individual or trust with a reasonable expectation of profit ...

(b) a supply of real property made... in the course of a business of the individual or trust ...

(c) a supply of a part of a parcel of land, which parcel the individual, trust or settlor of the trust subdivided or severed into parts, except where ... the parcel was subdivided or severed into two parts and the individual, trust or settlor did not subdivide or sever that parcel from another parcel of land ...

Under the circumstances, section 9 would have applied to exempt that part of the total Property that did not form part of the Complex.

The sale of the Property to W was therefore exempt from the GST by one of two means: either by operation of section 2 of Part I of Schedule V alone or in combination with section 9 of Part I of Schedule V.

Transfer of the Building Lots to B

The facts indicate that, subsequent to completing the sale of the Property to W, B retained an equitable interest therein. That B retained an equitable interest is demonstrated by the fact that B exercised XXXXX right under the Agreement to register the Agreement on title to the Property; furthermore, it corresponds with the covenants of the Agreement which require B to release any "... right, title or interest" XXXXX continued to hold in the Residence Parcel upon subdivision of the Property. Subsequent to subdivision, both parties therefore held undivided interests in the Residence Parcel and Building Lots until each transferred his/her interests to the other pursuant to the Agreement.

Pursuant to paragraph (b) of the definition of "real property" contained in subsection 123(1), legal and equitable interests in real property are themselves "real property". The respective interests of B and W in the Property were therefore considered to be real property for GST purposes.

The transfer of W's interests in the Building Lots to B, being a transfer of ownership, met the definition of "sale" in subsection 123(1). Accordingly, those transfers constituted sales of real property. Whether they were subject to tax depends on the application of the exempting provisions contained in section 9 of Part I of Schedule V.

As previously mentioned, section 9 of Part I of Schedule V exempts the sale of real property by an individual with certain exceptions. The exception contained in paragraph 9(2)(c) of Part I of Schedule V provides that the supply of a part of a parcel of land by a person who is an individual will not be exempt if the parcel was severed or subdivided by the person. There are exceptions to this rule. Specifically, where a parcel of land is subdivided or severed into only two parts and the person did not previously subdivide or sever it from another parcel of land, paragraph 9(2)(c) does not apply.

Since W subdivided the Property (albeit in concert with B) into more than two parts, the exclusionary provisions of paragraph 9(2)(c) applied to exclude the transfer of W's interest in the Building Lots from exemption. Since no other exempting provision is applicable in the circumstances, the transfer of these interests to B were taxable. In any event, since the consideration paid by B on the transfer was nil and the parties were dealing at arm's length, there was no tax payable for the supply.

Ultimate sale of the Building Lots by B

Paragraph 9(2)(c) is again relevant in determining the tax status of the ultimate sale of the Building Lots. Because B, in concert with W, subdivided the Property into more than two parts, paragraph 9(2)(c) applied to exclude the sale of the Building Lots from exemption. As no other exempting provisions are applicable in the circumstances, the sale of each of the Building Lots was a taxable supply. Tax was therefore payable at 7% of the value of consideration for the supply of the Building Lots.

Accounting for tax

Pursuant to subsection 221(1), every person who makes a taxable supply generally must collect any tax that is payable by the recipient of the supply and remit that tax pursuant to section 228. However, paragraph 221(2)(b) specifies that persons making taxable supplies of real property are not required to collect the tax payable where the recipient is registered for GST purposes and the supply is not a supply of a residential complex made to an individual.

In the present case, if B sold a Building Lot to a purchaser who was registered for GST purposes, XXXXX would have been relieved by paragraph 221(2)(b) from the obligation to collect tax on that Building Lot. In that case, subsection 228(4) would apply to require the purchaser to remit the tax payable directly to the Receiver General. However, if B sold a Building Lot to a non-registrant, XXXXX would have been required to collect and remit tax on that supply.

Should you have any further questions or require clarification on the above or any other GST or Harmonized Sales Tax matter, please do not hesitate to contact me at (613) 952-8816.

Yours Truly

Paul Hawtin
Rulings Officer
Real Property Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate