24 April 1996 Internal T.I. 9528207 - CORP. HOLDING LAND ON WHICH S/HS HAVE BUILT THEIR HOMES

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.Is XXXXXXXXXX holding land as an agent for its shareholders (who have built dwellings on the land)?

2.Are the "ground rentals", paid by the shareholders to XXXXXXXXXX income to XXXXXXXXXX or "shareholder contributions"?

3.Does XXXXXXXXXX qualify as an NPO under 149(1)(l)?

Position TAKEN:

1.No.

2.Income to XXXXXXXXXX

3. No.

Reasons FOR POSITION TAKEN:

1.•The Memorandum of Association of XXXXXXXXXX is clear that XXXXXXXXXX is to purchase the land and lease the land to its members, rather than to hold such land as agent for its members. Furthermore, the Memorandum of Association specifies that the liability of its members is limited, which supports a disassociation of the members from the property of XXXXXXXXXX

•The shareholders must pay a ground rental to XXXXXXXXXX As indicated in paragraph 4 of IT-437R, Ownership of Property (Principal Residence), "a tenant of a property...is not the beneficial owner of the property".

•A shareholder leaving the community within five years of residence owns no part of the property held by XXXXXXXXXX and receives no amount for such a part.

•There is no indication in the Agreement for Sale, pursuant to which XXXXXXXXXX acquired the property, that XXXXXXXXXX was acting as agent for its shareholders.

•There does not seem to be any indication that title to the property was registered as being held by XXXXXXXXXX as an agent for its shareholders.

•It is well established in jurisprudence that the separate legal existence of a corporation cannot be ignored for tax purposes.

2.The Memorandum of Association clearly indicates that XXXXXXXXXX is to lease land to its members and at the first directors' meeting it was resolved that the members would pay a ground rental. Furthermore, XXXXXXXXXX right to such amounts is absolute and under no restriction as to its disposition, use or enjoyment (i.e., such amounts have the "quality of income" as per Kenneth B.S. Robertson Ltd., 2 DTC 655). That is, there is no indication that such amounts are contributions or advances or that such amounts are to be repaid by XXXXXXXXXX except in the contingent event that a member leaves the community before a total of five years' residence is established, at which time, only a portion of the ground rental would be refundable. Until a member leaves the community within this period, any accrual for such a refund would represent a contingent liability and its deduction would be denied under paragraph 18(1)(e).

3.•XXXXXXXXXX Memorandum of Association does not provide that it was incorporated for non-profit purposes and, in fact, refers to the "carrying on" of a business.

•XXXXXXXXXX does not meet the requirement of 149(1) that no part of its income be available for the personal benefit of its members. A part of its ground rental is refundable should a member leave the community before five years' residence is established. Furthermore, if a member leaves the community after this period, he or she will be given his prorated share of the value of the property.

							April 24, 1996

	XXXXXXXXXX Tax Services Office	HEADQUARTERS
	Business Audit, XXXXXXXXXX		M. Azzi
	Attention: XXXXXXXXXX			957-8953

							7-952820

XXXXXXXXXX

This is in reply to your letter of October 24, 1995, wherein you requested our views regarding the tax status of a corporation which is holding land on which its shareholders have built dwellings and the tax implications of the shareholders receiving their prorated share of the land after subdividing the property. We apologize for the delay in responding to your request.

Facts

Our understanding of the facts is as follows:

XXXXXXXXXX

XXXXXXXXXX

Your Views

XXXXXXXXXX

Our Comments

Agency Relationship

Paragraph 1 of IT-216, Corporation Holding Property as Agent for Shareholder, provides that: "A corporation may hold in trust, as agent for a shareholder, property that was acquired specifically to be held in this way. This situation, however, will only be accepted as a fact where there is an agreement or declaration of trust, entered into before or at the time the property was acquired, between the corporation and the shareholder, which clearly sets out the intention of the parties to the agreement and the degree of participation of the shareholder in the property so held in trust." Furthermore, paragraph 1 of IT-493, Agency Cooperative Corporations, provides that: "The existence of an agency relationship is usually evidenced by a contract, agreement, charter, articles of association or by-laws describing either in general or in specific terms the extent to which the cooperative may act as an agent for its members and as a principal in its own right."

Although an agency relationship is usually supported by a written agreement to that effect, such a contract may be implied. An implied agency may be found to exist where the conduct of the parties shows an intention to create an agency.

Where it is established that property is held by a corporation as agent for a shareholder, the shareholder will be considered to be the beneficial owner of the property and all the normal consequences of ownership of the property will flow from the arrangement. Any income or loss arising in respect of property, including any recaptured capital cost allowances or terminal losses, while it is subject to the agency relationship, will be considered to be the income or loss of the shareholder regardless of whether any receipts have been transferred to the shareholder or, in the case of a loss, whether or not the corporation has been reimbursed.

In our view, the above-described facts do not indicate that XXXXXXXXXX acquired the land as an agent for its shareholders. The Memorandum of Association is clear that XXXXXXXXXX is to purchase the land and lease the land to its members, rather than to hold such land as agent for its members. Furthermore, the Memorandum of Association specifies that the liability of its members is limited, which supports a disassociation of the members from the property of XXXXXXXXXX Other indications that the property was not acquired by XXXXXXXXXX as an agent are:

a)the shareholders must pay a ground rental to XXXXXXXXXX As indicated in paragraph 4 of IT-437R, Ownership of Property (Principal Residence), "a tenant of a property...is not the beneficial owner of the property";

b)a shareholder leaving the community within five years of residence owns no part of the property held by XXXXXXXXXX and receives no amount for such a part;

c)there is no indication in the Agreement for Sale, pursuant to which XXXXXXXXXX acquired the property, that XXXXXXXXXX was acting as agent for its shareholders; and

d)there does not seem to be any indication that title to the property was registered as being held by XXXXXXXXXX as an agent for its shareholders.

Furthermore, it is well established in jurisprudence that the separate legal existence of a corporation cannot be ignored for tax purposes. This issue has been dealt with in cases such as Rex T. Parsons (84 DTC 6447, FCA), Kosmopoulos v. Constitution Insurance Company of Canada et al. (1987 1 S.C.R. 2), K. J. Beamish Construction Co. Limited (90 DTC 1584, TCC), Roger Lachappelle (90 DTC 1876, TCC), Tor-Guelph Holdings Limited and 309901 Ontario Limited (91 DTC 355, TCC), Pierre-Gilles Laframboise (92 DTC 2299, TCC), M. Donald Easton and Harold Freeman (92 DTC 6218, FCTD) and Jack Jennings (94 DTC 6507, FCA). In particular, in the case of Kosmopoulos v. Constitution Insurance Company of Canada et al., Madame Justice Wilson, of the Supreme Court of Canada, stated at page 10:

"As a general rule a corporation is a legal entity distinct from its shareholders: Salomon v. Salomon & Co. (1897) A.C. 22 (H.L.). The law on when a court may disregard this principle by "lifting the corporate veil" and regarding the company as a mere "agent" or "puppet" of its controlling shareholder or parent corporation follows no consistent principle. The best that can be said is that the "separate entities" principle is not enforced when it would yield a result "too flagrantly opposed to justice, convenience or the interests of the Revenue": L.C.B. Gower, Modern Company Law (4th ed. 1970), at p.112."

and at page 11 Madame Justice Wilson went on to say:

"There is a persuasive argument that those who have chosen the benefits of incorporation must bear the corresponding burdens, so that if the veil is to be lifted at all that should only be done in the interests of third parties who would otherwise suffer as a result of that choice: Gower, supra, at p.138."

In Freud (68 DTC 5279, SCC) Mr. Justice Pigeon of the Supreme Court, when commenting on the decision of that Court in Fraser v. M.N.R. (64 DTC 5224) stated that:

"...This decision (the decision reached in Fraser) does not in my view necessarily imply that the existence of the companies as separate legal entities was disregarded for income tax assessment purposes. On the contrary, it must be presumed that the companies remained liable for taxes on their operations and their title to the land, unchallenged. I must therefore consider that the decision rests on the view that was taken of the nature of the outlay involved in the acquisition of the companies' shares by the promoters."

In Rachman (85 DTC 5220, FCTD) an individual used a corporation to protect himself from the risk of lawsuits associated with the operation of a rental business. However, he claimed that the corporation acted as his agent. In his judgement the judge stated:

"That position taken by the plaintiff is contrary to the manner in which he set up the whole organization, and his purpose in doing so. The plaintiff, throughout, wished to avoid personal liability: hence the corporate entity. If the company were merely his agent for the purpose of running the business, then he would not be shielding his personal assets from responsibility for the lawful acts of his agent. I note, again, the position the plaintiff took in respect of the litigation, earlier referred to, involving a Royal Tower tenant.

The plaintiff cannot have it both ways..."

Since, in our view, XXXXXXXXXX is not acting as agent for its shareholders, it is both the legal and beneficial owner of the property. Consequently, a distribution of the property to the shareholders would, by virtue of section 69 of the Act, be deemed to be a disposition by XXXXXXXXXX at fair market value. Furthermore, subsection 15(1) of the Act may apply to tax a benefit conferred on the shareholders, as they will have acquired the property for an amount less than fair market value.

It should also be noted that since XXXXXXXXXX is owner of the property, subsection 15(1) of the Act would generally apply if the shareholders pay less than fair market rent for the property.

Ground Rental

Generally, an amount is considered earned by a taxpayer (has the "quality of income"), if the taxpayer's right to it is under no restriction, contractual or otherwise, as to its disposition, use and enjoyment, or the taxpayer's right to the amount is absolute and unconditional. This principle is derived from Kenneth B.S. Robertson Ltd. (2 DTC 655, Ex.Ct.), and has been adopted in other Canadian cases, including Burrard Yarrows Corporation (86 DTC 6459, FCTD - affirmed 88 DTC 6352, FCA), and Foothills Pipe Lines (Yukon) Ltd. (90 DTC 6607, FCA) (see also Brown v. Helvering - U.S. Supreme Court). In Robertson, Mr. Justice Thorson stated:

"...the question remains whether all of the amounts received by the appellant during any year were received as income or became such during the year. Did such amounts have, at the time of their receipt, or acquire, during the year of their receipt, the quality of income, to use the phrase of Mr. Justice Brandeis in Brown v. Helvering (supra). In my judgment, the language used by him, to which I have already referred, lays down an important test as to whether an amount received by a taxpayer has the quality of income. Is his right to it absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment? To put it in another way, can an amount in a taxpayer's hands be regarded as an item of profit or gain from his business, as long as he holds it subject to specific and unfulfilled conditions and his right to retain it and apply it to his own use has not yet accrued, and may never accrue?"

In our view, the ground rental paid to XXXXXXXXXX by its shareholders is income to XXXXXXXXXX and not shareholder contributions or advances. The Memorandum of Association clearly indicates that XXXXXXXXXX is to lease land to its members and at the first directors' meeting it was resolved that the members would pay a ground rental. Furthermore, XXXXXXXXXX right to such amounts is absolute and under no restriction as to its disposition, use or enjoyment. That is, there is no indication that such amounts are contributions or advances or that such amounts are to be repaid by XXXXXXXXXX except in the contingent event that a member leaves the community before a total of five years' residence is established, at which time, only a portion of the ground rental would be refundable. Until a member leaves the community within this period, any accrual for such a refund would represent a contingent liability and its deduction would be denied under paragraph 18(1)(e) of the Act.

Paragraph 149(1)(l) of the Act

To qualify for tax exempt status as an non-profit organization, under paragraph 149(1)(l) of the Act, the organization must both be organized and operated exclusively for social welfare, civic improvement, pleasure or recreation or for any other purpose except profit. A determination of whether the organization was organized exclusively for exempt purposes requires an examination of the organization's enabling documents. These documents may include letters of patent, articles of incorporation, memoranda of agreement, by-laws, articles and so on. In this respect, we note that XXXXXXXXXX Memorandum of Association does not provide that it was incorporated for non-profit purposes and, in fact, refers to the "carrying on" of a business.

Furthermore, to qualify under paragraph 149(1)(l) of the Act, no part of the income (as defined in subsection 149(2) of the Act) of an organization, whether current or accumulated, may be made available for the personal benefit of any member of the organization. As indicated in paragraph 11 of IT-496, Non-Profit Organizations, an organization may fail to comply with this requirement in a variety of ways, such as where:

a)the organization distributed income during the year, either directly of indirectly, to or for the personal benefit of any member;

b)the organization has the power at any time in the current or future years to declare and pay dividends out of income; or

c)the organization in the case of a winding-up, dissolution or amalgamation has the power to distribute income to a member.

In our view, XXXXXXXXXX does not meet the above restriction regarding the availability of its income and, consequently, does not qualify for exemption under paragraph 149(1)(l) of the Act, since a part of its ground rental is refundable should a member leave the community before five years' residence is established. Furthermore, if a member leaves the community after this period, he or she will be given his prorated share of the value of the property.

It should also be noted that the restriction regarding the availability of income would also not be met if XXXXXXXXXX shares have dividend rights. A review of XXXXXXXXXX articles of incorporation would be required to determine if the shares have such rights.

Finally, we note that your letter makes reference to condominium corporations and to the Income Tax Technical News No. 4 (the "ITTN") which provides that, although a factual determination is always required, most residential condominium corporations will qualify as non-profit organizations under paragraph 149(1)(l) of the Act. Please note that the position in the ITTN does not apply to XXXXXXXXXX as it is not a condominium corporation. Generally, a condominium corporation is a corporation without share capital, created under the respective provincial Condominium Act by the acceptance and registration of a "declaration and description", or a "strata plan", in the appropriate land registry or land titles office. Each member owns his or her "unit" or "strata lot" (hereinafter referred as a "unit") in fee simple, while the common areas of the condominium development are owned in common by all the unit owners. The function of a condominium corporation is to manage the condominium property and to administer the common elements for its unit owners. These owners are required by statute to make contributions and if they do not, a lien can be put on their unit. The use of such contributions is restricted. An owner has no power to demand that the funds be put to a specific purpose and does not receive any portion of such funds upon the sale of the unit.

We trust that these comments will be of assistance.

R. Albert
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch