4 June 2003 GST/HST Ruling 37913 - Liability to Collect Tax on Commercial Rent - Conversion of Commercial Property

Dear XXXXX:

Thank you for your letter XXXXX addressed to the XXXXX Tax Services Office, concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to the transactions described below. Your letter has been forwarded to us for our reply. We apologize for the delay in our response.

All legislative references are to the Excise Tax Act (the Act).

Statement of Facts

Our understanding of the facts and transactions is as follows:

1. You and XXXXX purchased certain real property (the Property) from XXXXX in XXXXX. The Property is located in XXXXX. We will assume that the purchase was made in joint tenancy and not by a partnership composed of you and XXXXX. The Property included a three-storey building, the top two of which XXXXX had leased to individuals as a place of residence on a long-term basis (i.e. the supplies were exempt under section 6 of Part I of Schedule V to the Act) (The second storey was leased to you and XXXXX.) and the main floor of which was leased to a XXXXX that operated a business from the premises. We will assume that the Property was capital property of XXXXX and that XXXXX had a reasonable expectation of profit from this rental business. Upon your purchase of the Property, you continued to occupy the second storey as your place of residence and continued to lease the other two storeys in the same manner as had XXXXX.

2. Both you and XXXXX were registered for the GST/HST at the time XXXXX sold the Property to you. There is no evidence that XXXXX was registered. XXXXX did not collect any tax on the sale. There is no evidence to suggest that you reported any tax payable on the purchase of the Property.

3. The only commercial activity you are engaged in is the lease of the main storey of the building to the XXXXX. The revenue from this activity is below $30,000 per year. Once the lease to the XXXXX is terminated, you intend to use the main storey of the building for your personal use and enjoyment as your primary place of residence.

4. You charge the XXXXX $XXXXX per month for the lease of the main storey. Based on a review of your GST/HST returns, you are reporting all of the revenues from the supply. We will therefore assume that you alone are making a supply of the leased premises to the XXXXX.

5. We will assume that XXXXX was not a builder of the residential complex part of the Property and that XXXXX did not claim any input tax credits in respect of the acquisition or improvements made to that part of the Property.

You raised the following questions (in addition to other questions that will be answered later in the response).

Rulings Requested

1. Did the GST apply to any portion of the sale of the Property from XXXXX to you?

2. Should you be collecting and remitting GST on the lease of the main storey to the XXXXX? If not, can you cease doing this?

3. If the lease to the XXXXX expires and you convert the main floor for use as your personal residence, are there any GST implications to the conversion? If the Property were then sold at some time after the conversion, would the GST apply to the sale?

Rulings Given

Based on the facts set out above, we rule that:

1. The sale by XXXXX to you of that portion of the Property that XXXXX leased to the XXXXX is subject to the GST. The sale of that part of the Property that was a residential complex is exempt under section 2 of Part I of Schedule V to the Act.

2. You are required to collect and remit the GST on the lease of the main storey to the XXXXX. You are required to do this as long as you are a GST/HST registrant.

3. If the lease to the XXXXX ends and you convert the main storey such that it begins to be used for your personal use and enjoyment (which includes using it as your primary place of residence), you will be required to remit an amount equal to 7% of the fair market value (as determined at the time of the conversion) of that part of the Property that was not a residential complex. If the basic tax content of that part of the Property at the time of the conversion is greater than 7% of the fair market value at that time, the difference between these amounts will also need to be remitted. A subsequent sale of the Property would be exempt, provided you were using the Property primarily as your place of residence immediately before that sale.

These rulings are 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 these rulings 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 Excise Tax Act, or to our interpretative policy; and that you have fully described all necessary facts and transactions for which you requested a ruling.

Explanation

Ruling #1 - The sale of the Property from XXXXX to you

The term "residential complex" is defined in subsection 123(1) to include that part of a building in which one or more residential units are located together with that part of any common areas and other appurtenances to 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.

In this case, the top two storeys of the building are residential units. Further, in accordance with the definition of residential complex, a portion of the common areas, appurtenances, the immediately contiguous land and the subjacent land will also form part of the residential complex. However, the main storey of the building and some portion of the common areas, appurtenances, immediately contiguous land and the subjacent land will not form part of the residential complex.

Where a supply (which includes a sale) of real property includes a residential complex and other real property that is not a residential complex, subsection 136(2) deems the supply of the residential complex and that part that does not form part of a residential complex to be separate supplies and neither supply is incidental to the other.

The sale of that portion of the Property that is the residential complex will be exempt under section 2 of Part I of Schedule V to the Act. That section exempts the sale of a residential complex made by a person who is not a builder of the complex where the person did not claim an input tax credit in respect of the last acquisition of the complex or in respect of an improvement to the complex since it was last acquired.

The sale of that portion of the Property that is not a residential complex is subject to the GST as there are no provisions to exempt such a supply in these circumstances.

Ruling #2 - The lease of part of the Property to the XXXXX

Your lease of a residential unit in a residential complex (i.e. your lease of the third storey) is exempt under section 6 of Part I of Schedule V to the Act. That section exempts the lease of a residential unit in a residential complex if the unit is to be used by an individual as a place of residence or lodging and if the rental period is a period of continuous occupancy or right of occupancy of one month or more to the same individual.

No exemption exists for the lease of the main storey to the XXXXX that uses the premises for non-residential purposes. This lease to the XXXXX is a taxable supply. A registrant that makes a taxable supply by way of lease of real property is required to collect tax on the supply. Accordingly, as a registrant, you are required to collect the GST on the supply made by way of lease to the XXXXX. (Similarly, when XXXXX owned the Property, her lease of both the third storey and the second storey, the latter of which was leased to you as a place of residence, was an exempt supply under section 6 of Part I of Schedule V to the Act. Her lease to the XXXXX was a taxable supply.)

Ruling #3 - Conversion of part of the Property from leasing to XXXXX to your residence

If the lease of part of the Property to the XXXXX ends and you convert that portion of the Property to use as your place of residence (or indeed for any personal use or enjoyment), subsection 190(2) would apply to deem you to have made and received a taxable supply by way of sale of that portion of the Property. You would be deemed to have paid as recipient and collected as supplier, tax in respect of the supply based on the fair market value of that part of the Property at the time of the conversion.

Where the Property ceases to be used in commercial activities (e.g. you begin to use two storeys as your place of residence and the third storey is used to make exempt supplies under section 6 of Part I of Schedule V to the Act) or where the Property begins to be used primarily for your personal use and enjoyment, subsection 207(1) will apply.

Pursuant to paragraph 207(1)(a), where an individual who is a registrant ceases to use capital real property in a commercial activity and begins to use the property exclusively (90% or more) for other purposes, or primarily (more than 50%) for the individual's or a related individual's personal use and enjoyment, the registrant is deemed to have sold the property immediately before this change-in-use. Except where the supply is an exempt supply, the individual is deemed to have collected tax on the deemed sale, calculated as:

A - B

where

A is the basic tax content of the property at the time of the deemed sale, and

B is the tax, if any, the individual is deemed to have collected under the self-supply provisions in section 190.

As it applies to this case, the deemed sale under paragraph 207(1)(a) is not that of a residential complex and, if the deemed sale is not exempt under section 9 of Part I of Schedule V (discussed below) to the Act, is a taxable supply. As subsection 190(2) also applied in this case, the tax owing thereunder would reduce, perhaps to zero, the tax owing under subsection 207(1).

Pursuant to subsection 123(1) of the ETA, the "basic tax content" of a property is generally calculated as:

(a) the amount of GST/HST that was payable on the last acquisition of the property and on any improvements made to the property since it was last acquired;

(b) from this sum, one must deduct any amounts (other than input tax credits) that the person was entitled to recover by way of rebate, refund, remission or otherwise;

(c) the result is then multiplied by a factor that takes into account the fair market value of the property at the time the basic tax content is being determined and the cost of acquiring the property or improvements thereto.

The enclosed guide, "General Information for GST/HST Registrants", provides the formula for calculating the basic tax content of property.

If you were to sell the Property at some time after the conversion, provided the building was used primarily as your place of residence (or that of a relation to you or a former common law spouse of yours) immediately before the sale and that all of the land and appurtenances are reasonably necessary for residential use, the sale would be exempt under section 2 of Part I of Schedule V to the Act. Section 2 exempts the sale of a residential complex by a person who is not the builder of the complex, unless the person claimed an input tax credit in respect of the last acquisition of the complex or in respect of an improvement to the complex since it was last acquired.

You also raised the following questions:

Interpretations Requested

1. If you were to sell the Property while the lease to the XXXXX is still in place, would the GST apply to any part of the consideration for the sale?

2. If the lease to the XXXXX ended and you did not lease the premises formerly occupied by the XXXXX to any other person and you then sold the Property, what would be the GST implications of a sale of the Property at that time?

3. You also enquired as to the GST implications of cancelling your registration.

Interpretations Given

1. The sale of that portion of the Property that you leased to the XXXXX would attract the GST. The sale of that part of the Property that was a residential complex would generally be exempt under section 2 of Part I of Schedule V to the Act.

2. If the lease to the XXXXX ends and you sell the Property, the sale of that part of the Property that was leased to the XXXXX will attract the GST, unless it can be demonstrated that the use in commercial activities of that part of the Property ceased and either that part also began to form part of the residential complex or you began to use that part for your own personal use and enjoyment. If either of these events occurred, you would be subject to the application of sections 190 and 207 at the time of such a change-in-use (see discussion in the explanation of Ruling #3, above).

3. If you cancelled your registration when the lease to the XXXXX was still in place, you would generally be required to account for tax on the basic tax content of that part of the Property that was leased to the XXXXX. If you cancelled your registration at some time after the conversion of that part of the Property, there would be no additional tax owing at the time of cancellation of registration. However, you would have incurred a tax liability under subsection 190(2) and possibly subsection 207(1) (as discussed above).

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed amendments to the Excise Tax Act, if enacted, could have an effect on the interpretation provided herein. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST/HST Memoranda Series, do not bind the Canada Customs and Revenue Agency with respect to a particular situation.

Explanation

Interpretation #1 - Your sale of the property while leasing part of it to the XXXXX

f you were to sell the Property while leasing part of it to the XXXXX (or to any person using the premises for non-residential purposes), the treatment would be similar to the sale made by XXXXX to you. Provided you were not using the Property primarily as your place of residence at the time of such a sale, the sale would be considered that of a residential complex and other real property that is not a residential complex (i.e. the rules in subsection 136(2), as discussed above, would apply).

The exemption in section 2 of Part I of Schedule V to the Act would apply to that part of the Property that is a residential complex if you were not a builder of the complex and no input tax credits were claimed on the acquisition of the complex or any improvements made thereto. The GST would apply to that part of the Property that is not a residential complex as there are no provisions to exempt such a supply in these circumstances.

Interpretation #2 - Your sale of the property where the lease to the XXXXX ends and you do not enter into another lease

If you were to sell the Property at some time after the lease to the XXXXX ended and those premises sat empty after that time and before the time of sale, we would generally consider a supply of the Property to still be that of a residential complex and other real property that is not a residential complex. Such a conclusion is based on the assumption that the premises have not been taken out of use in a commercial activity and have not begun to be used in another manner.

If evidence established that the use in commercial activities ceased by virtue of the fact that you began to use the premises as your place of residence or you leased the floor for residential purposes such that it formed part of the residential complex, the sale of the Property would generally be exempt under section 2 of Part I of Schedule V to the Act. However, in such a case, the rules as set out in the Explanation to Ruling #3 would apply at the time of the conversion. Alternatively, if after the cessation of use in commercial activities you began to use that part of the Property in an exempt use (but not for residential purposes), the rules in section 207 would apply at the time of the change-in-use. A subsequent sale of the Property would be that of a residential complex (generally exempt) and other real property that is not a residential complex (generally subject to tax).

Interpretation #3 - Cancellation of Registration

Given that you are a small supplier and have been registered for at least one year, you are entitled to cancel your GST/HST registration pursuant to subsection 242(2). If the registration is cancelled at a time when the lease to the XXXXX is still in effect, there would be change-in-use implications to the deregistration. Paragraph 171(3)(b) provides that where a person ceases to be a GST/HST registrant, the person is deemed to have ceased using capital real property in commercial activities. The change-in-use rules under paragraph 207(1)(a) would apply (see the Explanation to Ruling #3, above). (It must be noted that in this case subsection 190(2) would not apply and as such, element B in subsection 207(1) would be zero.) If the registration were cancelled at some time after the conversion of the Property, and the Property was not used in your commercial activities at the time of deregistration, paragraph 171(3)(b) would not apply, meaning there would be no deemed cessation of use in commercial activities and no deemed sale under that paragraph at the time of deregistration. However, in that case the rules under paragraph 207(1)(a) would apply at the time of the conversion.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at 613-954-4393.

Yours truly,

Hugh Dorward
Real Property Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate

Encl.