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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
1.Upon becoming mortgagee in posession, does the mortgagee acquire beneficial ownership of the property for purposes of section 79 or 79.1.
2.Treatment of rental income earned on the property relative to the mortgagee in possession and the mortgagor.
Position TAKEN:
1.No.
2.Income is that of mortgagor and is applied against amounts owing under the mortgage.
Reasons FOR POSITION TAKEN:
Matter of law.
October 26, 1995
XXXXXXXXXX Tax Services Office Headquarters
B. G. Dodd
Attention: XXXXXXXXXX (613) 957-8953
Business Enquiries
951872
Section 79.1 of the Income Tax Act
We are writing in reply to your memorandum dated July 7, 1995. We apologize for the delay. All references to statute are to the Income Tax Act.
FACTS
You describe the facts as follows.
XXXXXXXXXX
XXXXXXXXXX
DISCUSSION
Section 79.1 applies with respect to a creditor where the creditor has seized a property at any time in a particular year in respect of a debt. As set out in subsection 79.1(2), a property is seized at any time by a person in respect of a debt where the beneficial ownership of the property is acquired or reacquired at that time and the acquisition or reacquisition was in consequence of another person's failure to pay to the person all or part of the specified amount of the debt.
The point in time at which a taxpayer can be considered to have acquired or reacquired beneficial ownership of property is a question of law which can only be determined based on a complete review of all the relevant circumstances. Inasmuch as the above facts were relayed to you in the course of a telephone enquiry by the principal shareholder of XXXXXXXXXX we are concerned that all of the relevant facts are not available (including, for example, the mortgage agreement in its entirety) and are therefore reluctant to comment definitively on XXXXXXXXXX situation. However, the following observations may be of some assistance in this matter.
The term "beneficial ownership" describes the ownership of a taxpayer who is entitled to the use and benefit of property whether or not he has concurrent legal ownership. Factors to be considered (some of which are discussed in paragraph 8 of IT-170R as you point out) include the right to possession, the right to collect rents, the right to call for the mortgaging of the property, the right to transfer title by sale or will, the obligation to repair, the obligation to pay property taxes and other relevant rights and obligations. In our view, the registration of a quit claim deed (as discussed in IT-505) on the property in due course after default would generally be indicative of these attributes being present such that beneficial interest in the property could be said to have been reacquired by XXXXXXXXXX at that time.
That is not to say that XXXXXXXXXX could not have reacquired beneficial ownership of the property at an earlier time but this would have to be borne out by the facts. From the information available, we are unable to conclude that this was the case. For example, while XXXXXXXXXX is said to have been a "mortgagee in possession" of the property after the default, it is unclear how this came about given that, as discussed with you by telephone, XXXXXXXXXX did not initiate any legal proceedings to obtain a writ of possession (eg., was it pursuant to the terms of the mortgage, some agreement between XXXXXXXXXX and the developer, etc?).
XXXXXXXXXX
In addition, it is our understanding that a mortgagor's beneficial interest in a property includes an "equity of redemption", being the mortgagor's right to redeem his property from default. While it exists, the mortgagor would have the right to block any action taken by the mortgagee by bringing the mortgage back into good standing, thereby ensuring it has the benefits of ownership. This right would normally exist until foreclosure proceedings are initiated or the mortgagor otherwise gives up or loses that right, for example, as a result of a quit claim. Whether the developer's equity of redemption in the property was lost or otherwise disposed of by the developer prior to the registration of the quit claim is a question of fact but the information available does not indicate this to be the case.
With respect to the second issue which is concerned with the rental income derived from the property as mortgagee in possession, it is our understanding that such income is that of the mortgagor and that it is applied against the mortgagor's obligations under the mortgage to the mortgagee. To the extent that rent received by XXXXXXXXXX constituted income to the developer and was applied to reduce the developer's obligations under the mortgage, it is our view that the amounts are income to the developer for tax purposes and must be reported as such. The related mortgage interest expense would be deductible by the developer, assuming it was otherwise deductible. Such rent would not constitute a capital receipt by XXXXXXXXXX but rather, an amount received and applied on account of amounts due under the mortgage (interest in this case) and as such, would be income to XXXXXXXXXX for tax purposes and may reduce any entitlement by XXXXXXXXXX to a doubtful debt reserve under paragraph 20(1)(l).
XXXXXXXXXX
You suggest it is unreasonable that a mortgagee could postpone the time at which it reacquires beneficial interest of a property in the case of a default by simply deferring the date at which a quit claim deed is registered, particularly if the amounts received by a mortgagee in possession are capital rather than on income account. You suggest this could allow for a considerable deferral or avoidance of tax. We would note the following.
-As indicated above, amounts received by the mortgagee would be received and applied on account of amounts owing by the mortgagor under the mortgage, whether capital, interest or both. It would seem to us that the mortgagee is in no different position vis a vis income or capital receipts than he would be if the mortgage were not in default (other than the amount of rent or other income from the property may be less than the required mortgage payments). In other words, if there is an amount of interest due under the mortgage, it will be satisfied, in the case of non-default, by the direct payment thereof by the mortgagor and in the case of default, by the application of rental or other income received from the property. In either case, the mortgagee has received mortgage interest which constitutes income. Similarly, where the amount relates to principal due under the mortgage, the application of rental or other income from the property (or in the case of non-default, the direct payment by the mortgagor) would be on account of principal.
-Whether beneficial ownership has been acquired prior to the registration of a quit claim deed is a question of fact.
In conclusion, we would suggest that if XXXXXXXXXX considers that beneficial ownership was acquired prior to the registration of the quit claim, it should be in a position to substantiate this. This would entail a review of all relevant facts and documents such as might be examined in the course of an audit. We would also suggest that an examination of the developer's reporting of the transactions would be in order. For example, if the developer reported the disposition of the property as occurring upon the registration of the quit claim, that may suggest there was good reason to do so. In any event, there should be consistent treatment by both parties.
We hope the foregoing will be of assistance to you. If there is anything you wish to discuss, please feel free to contact us at the above number.
Section Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings
and Interpretations Directorate
ENDNOTES
1. In allowing for the bad debt of $XXXXXXXXXX, it appears you are using paragraph (b) of the definition of specified cost in subsection 79.1(1), which applies where the debt is other than capital property. Although a question of fact, given that the disposition of the property was considered to be on capital account, you may wish to consider whether paragraph (a) of the definition of specified cost would be more appropriate.
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