7 October 2024 External T.I. 2022-0944011E5 - Treatment of legislated rescission fee

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1) Whether a legislated rescission fee is subject to income tax. 2) Whether the rescission fee may be considered to be proceeds for the disposition of a principal residence. 3) Whether any costs are deductible against the rescission fee. 4) Whether the payor of the rescission fee must report it to the CRA.

Position: 1) Question of fact, depending on the purpose of the rescission fee. 2) No. 3) Question of fact, depending on whether the costs are on account of income or capital. 4) No.

Reasons: 1) Surrogatum principle. 2) It appears there is no disposition of property when the contract is rescinded. 3) Question of fact. 4) Wording of the Act.

XXXXXXXXXX							2022-094401
								Matthew Ross, CPA, CA

October 7, 2024

Dear XXXXXXXXXX:

Re: XXXXXXXXXX Home Buyer Rescission Period – Income Tax Implications of a Rescission Fee

This is in reply to your correspondence dated July 21, 2022, wherein you asked several questions regarding the potential income tax implications of a “rescission fee” paid pursuant to section 42 of the Property Law Act (footnote 1) (“the PLA”) and the Home Buyer Rescission Period Regulation (footnote 2) (“the HBRP Regulation”). This legislation came into effect on January 3, 2023. We apologize for the delay in responding.

It is our understanding that the PLA and the HBRP Regulation provides a Home Buyer Rescission Period (“the Rescission Period”) of three business days. During the Rescission Period, a prospective home buyer (“the Purchaser”) may rescind a contract (“the Contract”) for the purchase of “residential real property” (“RRP”) (footnote 3) with the payment of a financial penalty (“the Rescission Fee”) to the prospective seller (“the Seller”). The Rescission Fee is 0.25% of the purchase price as set out in the Contract.

You have indicated that the Rescission Fee serves two main purposes. First, it seeks to deter Purchasers from entering into Contracts for multiple properties where their intention might be to rescind all but the most attractive offer. Second, the Rescission Fee compensates the Seller for any additional costs and inconvenience associated with continuing their efforts to sell the RRP to a new Purchaser.

You have asked the following:

1. How is the receipt of a Rescission Fee by a Seller treated for income tax purposes under the Income Tax Act (“the Act”)?

2. Where the Rescission Fee is received in respect of the intended sale of the principal residence of the Seller, can the Rescission Fee be included in the proceeds of disposition of the property?

3. Can a Seller deduct any expenses incurred in respect of the rescinded Contract?

4. Must a Purchaser report the payment of the Rescission Fee on an information return?

Our Comments

This technical interpretation provides general comments about the provisions of the Act and the Income Tax Regulations (“the Regulations”). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

1. Taxation of the Rescission Fee

It is necessary to review the various provisions of the Act and principles established under case law that may apply to include the Rescission Fee in the Seller’s income. Generally, an amount is taxable under the Act if it constitutes income from a source or if a specific provision of the Act applies to the type of payment. The characterization of a particular receipt for income tax purposes may differ from case to case, depending on the facts of each situation.

In general, Canadian courts have relied on the surrogatum principle to determine the income tax consequences of a compensation payment, where the tax treatment of a particular amount depends on what that amount is intended to replace. In making this determination, the nature and purpose of the payment is examined. As set out in Tsiaprailis v. The Queen, 2005 SCC 8,

“The determinative questions are: (1) what was the payment intended to replace? And, if the answer to that question is sufficiently clear, (2) would the replaced amount have been taxable in the recipient’s hands?”

Where an amount is received in the course of earning income from a business or property, it would generally be included in the taxpayer’s income under paragraph 3(a) of the Act as part of the computation of profit, as required by subsection 9(1) of the Act.

On the other hand, paragraph 3(b) of the Act includes in income any taxable capital gain realized by a taxpayer on the disposition of property. In this regard, subparagraph 40(1)(a)(i) of the Act provides that a taxpayer’s gain from the disposition of a capital property is the amount by which their proceeds of disposition exceed the aggregate of the adjusted cost base of the property immediately before the disposition and any outlays and expenses incurred for the purpose of making the disposition.

You have indicated that the Rescission Fee is intended to compensate the Seller for additional costs arising because of the rescission of the Contract. In our view, these could include legal fees, listing expenses, or other costs incurred in continuing their efforts to sell an RRP to a new purchaser. If this is the case, where the Contract relates to the sale of RRP that is inventory of the Seller held in the course of earning income from a business or property, any such costs (“the Costs”) incurred by the Seller would generally be on account of income and would be included in the computation of their profit under subsection 9(1) of the Act. Accordingly, following the surrogatum principle, where the Rescission Fee is intended to compensate the Seller for the Costs on the rescission of a Contract for RRP that would have been on income account, the Rescission Fee would also be on income account and would be included in the Seller’s income pursuant to subsection 9(1) of the Act.

Alternatively, where the Contract relates to the sale of RRP that is capital property of the Seller, the Costs incurred by the Seller would generally be on account of capital. Only outlays or expenses made or incurred for the purpose of making the disposition would be applied against any proceeds of disposition pursuant to subparagraph 40(1)(a)(i) of the Act when the disposition takes place. Where the Contract has been rescinded, however, it may be that no disposition has yet taken place that entitles the Seller to proceeds of disposition. In these circumstances, the Costs cannot result in a loss under subparagraph 40(1)(b)(i) of the Act at the time the Contract is rescinded and they are not otherwise deductible in computing the income of the Seller under subsection 9(1) of the Act. As such, following the surrogatum principle, where the Rescission Fee is intended to compensate the Seller for the Costs on the rescission of a Contract for RRP that would have been on capital account, the Rescission Fee would be a non-taxable receipt for the Seller because the Costs it replaces would not be deductible under subparagraph 40(1)(a)(i) of the Act.

To summarize, although the determination of the income tax treatment of the Rescission Fee is a question of fact, since you have indicated that the Rescission Fee is intended to compensate the Seller for additional costs arising from the rescission of the Contract, if a Seller holds RRP as inventory in the course of earning income from a business or property, any Rescission Fee received would be included in the Seller’s income pursuant to subsection 9(1) of the Act. Where, however, a Seller holds RRP as capital property (either for personal use or for the purpose of gaining or producing income from a business or property), any Rescission Fee received would not be taxable to the Seller.

2. Rescission Fee and proceeds of disposition of the RRP

“Proceeds of disposition” is defined in section 54 of the Act to include, among other things, “the sale price of property that has been sold.” While the PLA and the HBRP Regulation provides the Purchaser with the right to rescind the Contract during the Rescission Period, where the Contract is rescinded, a disposition of RRP has not taken place. Accordingly, the Rescission Fee cannot be considered to be proceeds of disposition for RRP and it is not possible for the Seller to add a Rescission Fee received to proceeds of disposition for RRP.

3. Can a Seller deduct any expenses incurred in respect of the rescinded Contract?

Generally speaking, an outlay or expense would be deductible from business or property income under subsection 9(1) of the Act, subject to the various limitations in the Act, such as paragraph 18(1)(a), paragraph 18(1)(h) and section 67. Accordingly, where the Contract is in respect of RRP that is inventory of the Seller held in the course of earning income from a business or property, any costs incurred in respect of the rescinded Contract would generally be on account of income and would be deductible.

Subparagraph 40(1)(a)(i) of the Act provides a deduction, in the computation of a taxpayer’s gain from the disposition of property, of any outlay or expense made or incurred for the purpose of making the disposition. The words “for the purpose of” in subparagraph 40(1)(a)(i) of the Act are directed to the action of making a particular disposition. The outlays and expenses in that provision are directed to a particular disposition and no other (Avis Immobilien GMBH v The Queen, 94 DTC 1039). Put differently, in order for an outlay or expense to be deducted pursuant to subparagraph 40(1)(a)(i) of the Act, they must be made for a particular disposition and not an eventual disposition.

Therefore, where the Contract is in respect of RRP that is capital property of the Seller, but the Contract has been rescinded by the Purchaser, the costs incurred in respect of the rescinded Contract cannot be said to have been incurred for the purpose of making the disposition of the RRP. Accordingly, they may not be deducted in computing the gain or loss on the eventual disposition of the RRP under subparagraph 40(1)(a)(i) of the Act.

4. Must a Purchaser report the payment of the Rescission Fee on an information return?

Part II of the Regulations imposes an obligation to file an information return on persons who make certain payments. These provisions can apply to a wide variety of payments; whether a payer is obligated to file an information return in respect of a payment rests substantially upon the determination of whether such payment is included in any of the provisions listed in Part II of the Regulations. As payments such as the Rescission Fee are not described in Part II of the Regulations, it is our view that a Purchaser does not have an information return reporting requirement in regard to the payment of a Rescission Fee.

We trust our comments will be of assistance.

Yours truly,

Sandro D’Angelo, CPA, CMA
Manager
Business and Capital Transactions Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 R.S.B.C. 1996, c. 377.

2 B.C. Reg. 175/2022 O.C. 436/2022.

3 RRP is defined in the HBRP Regulation.