5 March 1998 GST/HST Interpretation HQR0000928 - Change-in-Use and the Combined Supply of Real Property

                                                                        Financial Institutions and
Real Property Unit
Rulings and Interpretations
25 McArthur Ave.
Vanier, ON
XXXXX                                                                                 K1A 0L5

Dear XXXXX

Thank you for your letter of August 29, 1997 concerning the application of the Goods and Services Tax (GST)Harmonized Sales Tax (HST) to the following fact situation.

All legislative references are to the Excise Tax Act (the Act) and regulations thereunder, unless otherwise specified. This letter does not reflect any legislation regarding the provincial component of the HST.

Statement of Facts

A corporation that is registered for the GST will purchase real property that is used as a hotel.

The corporation (owner) will rent the property to another corporation (operator) who will carry on the commercial activity of operating the hotel.

You understand that the GST would be applicable to the rental payments and that the operator would be entitled to input tax credits (ITCs) in respect of this GST as it is carrying on a commercial activity.

Over a period of time, the operator will change the use of the real property from providing hotel accommodations to providing longterm residential rents to senior citizens in the format of a nursing home.

The exact timing of the change over of units will be dictated by the demand for the nursing home units. It is anticipated that of the 200 units in the building, 20 per year for the next ten years would be the approximate rate of conversion.

You understand that the rental of rooms in a nursing home constitutes an exempt supply of longterm residential rents under section 6 of Part 1 of Schedule V. As a result, the operator will be engaged both in commercial activities (hotel) and exempt activities (nursing home) in the same building. As a result, the operator will not be entitled to full input tax credits once the conversion takes place.

You also understand that the GST may no longer be payable by the operator to the owner on the monthly rental payments, or a portion thereof, for the building by virtue of section 6.1 of Part 1 of Schedule V.

Interpretation Requested

You would like us to comment on the Department's treatment of vacant units in the building that will be rented as nursing home units but were last used as hotel units. You question whether the changeinuse occurs at the time the unit became vacant or at the time it first becomes occupied as a nursing home unit.

You would like to know the exact portion of the monthly rent that would be exempt. You would like to know that if after the first month, 10 out of the 200 units were used as nursing home units, would 120th x of the monthly rent payments be exempt of the GST? If after the first 12 months, 20 of the 200 units were used as nursing home units, would 110th of the monthly rent payments be exempt of the GST? Or, alternatively, does the rent for the entire building become exempt once more than 50% or 90% of the units are rented as nursing home units?

You would like to know what documentation is required by the owner from the operator to satisfy the conditions of section 6.1 of Part I of Schedule V where the owner and operator are dealing at arms length.

You would also like to know if the owner can continue to charge the GST on the full rental payments despite the fact that a portion of the building is being used to provide exempt longterm residential rents in a nursing home environment, if the owner does not know the actual use to which the building is being put?

Interpretation Given

Tax Application With Respect to the Conversion

A "residential unit" as defined in subsection 123(1) includes "a suite or room in a hotel, a motel, an inn, a boarding house or a lodging house or in a residence for students, seniors, individuals with a disability or other individuals". However, the definition of a "residential complex", as per subsection 123(1), does not include "a building, or that part of a building, that is a hotel, a motel, an inn, a boarding house, a lodging house or other similar premises" where 90% or more of the units are supplied for periods of continuous possession or use of less than sixty days.

As the process of the conversion has not yet been determined, there are several possibilities to the manner of the conversion from hotel to longterm residence. It is possible that only one unit is initially converted, or that a block of units are initially converted. After the initial conversion, it is possible that the remainder of the units are also converted on unit by unit basis, or in blocks of units.

Because the hotel does not qualify as a "residential complex" for GST purposes, when the initial change to use as a nursing home occurs, we apply section 190 which deals with situations where real property is converted for use, or begins to be used, for residential purposes. Subsection 190(1) of the Act applies where a person converts nonresidential real property into a residential complex without constructing or substantially renovating the complex. Where the conversion of the property is to residential use, subsection 190(1) deems the conversion to be a substantial renovation and in most cases (including this one), the person to be a builder of the residential complex. The builder is then treated as having made a taxable supply pursuant to subsection 191 where tax is paid at the later of the time construction or renovation is substantially completed and the time possession is given to another person under the rental agreement. The GST is to be calculated on the fair market value of the complex or unit.

If the initial conversion is to a "single unit residential complex", defined in subsection 123(1) to mean "a residential complex that does not contain more than one residential unit, but does not include a condominium unit", subsection 191(1) would apply to require the builder to selfassess on the converted property. However, if the initial conversion is to a "multiple unit residential complex", defined in subsection 123(1) to mean "a residential complex that contains more than one residential unit, but does not include a condominium complex", subsection 191(3) would apply and require the builder to selfassess on the entire complex at the later of the time construction or renovation is substantially completed and the time the first unit is rented out (or occupied by the builder if the builder is an individual).

As it is the operator that is converting the property for residential purposes and it is the operator that satisfies all of the conditions of subsection 190(1) of the Act, it is the operator that is deemed to have substantially renovated the complex and the operator who is deemed to be the builder of the residential complex. It is the operator who will be required to selfassess the tax for GST purposes on that part of the building that constitutes a residential complex.

Subsection 190(1) will apply on the initial conversion of the applicable units of the hotel to longterm residential units, regardless of the number of units being changed. Subsection 206(5), a changeinuse rule, would then come into effect when the builder (in this case, the operator) reduced the extent to which the hotel was used in a commercial activity, without ceasing to use it in a commercial activity. The builder (operator) is deemed to have made a supply at that time and to have collected tax on that portion of the property that is no longer used in commercial activity. The tax deemed to have been collected is equal to the basic tax content of that portion of the property that is no longer being used in a commercial activity. However, in further consideration of this, section 197 of the Act provides that an insignificant changeinuse (i.e. a change that is less than 10% of the total use), will not be treated as a changeinuse. Hence, if the remaining hotel property is converted on a unit by unit basis, the changeinuse rules would only come into effect at the time the changes of the use of the property can cumulatively be considered 10% or more of the total use of the property.

Please note that the determination of when the changeinuse actually occurs is a question of fact that is determined on a case by case basis. The changeinuse will occur when the property has ceased to be used in a commercial activity and begins to be used in an exempt activity. In the absence of any actual use of the property, issues such as the completion of renovations, architectural plans, marketing and advertising as well as proposed rental agreements would be considered in determining the property's intended use.

Tax Application with Respect to Monthly Lease Payments

Section 6.1 of Part I of Schedule V exempts certain leases of land or residential buildings to a person who, in turn, leases the property on an exempt basis. This section applies to the supply of land, a building, or that part of a building, that forms part of a residential complex or that consists solely of residential units, or a residential complex.

The exemption in section 6.1 of Part I of Schedule V applies to a lease interval rather than the full lease and only if, throughout the lease interval, the recipient lessee or any sublessee is making, or intends to make, an exempt lease of the land under section 6, 6.1 or 7 of Part I of Schedule V. A lease interval, as per subsection 136.1(1), is "a period that is the whole of a part of the period during which possession or use of the property is provided under the arrangement" for which a payment is attributable to (e.g. a month would be a lease interval in the case of a twelve month lease requiring monthly lease payments).

Section 6 of Part I of Schedule V exempts supplies by way of lease, licence or similar arrangements of a residential complex or residential unit in a residential complex for the purpose of its occupancy as a place of residence or lodging under which continuous occupancy is provided for a period of at least one month.

Subsection 136(2) provides that where a supply of real property is made that includes a residential complex and other real property that is not a residential complex, the provision of the residential complex is treated as a separate supply from the provision of the other property. This applies to a supply by way of sale and a supply by way of lease, licence or similar arrangement. This subsection deems the owner to have made two supplies.

Therefore, as the operator converts the units in the hotel and changes the supply from taxable to exempt rents, the tax status of the lease between the owner and the operator in respect of that part of the building, will also change to exempt status at the appropriate lease interval. Subsection 136(2) will deem there to be two separate supplies and the rent should be prorated in respect of the use of the property in commercial (taxable) versus exempt activities.

Please note that the rent for the entire building does not become exempt once 50% or 90% of the units are converted to long term residential units.

The Act does not contain any specific guidelines for determining the method for prorating the value or extent of the use of the property being used in commercial activities, however, any method which is considered to be fair and reasonable in the circumstances will generally be accepted. Please note that once adopted, a particular method must be used consistently.

Documentation required

The legislation does not require any particular documentation to meet the qualifications in section 6.1 of Part I of Schedule V, however, documentation should clearly show that a supply by way of lease, licence or similar arrangement meeting the additional qualifications under that section is being made.

Tax Application with Respect to the Intention of Use for Property Versus the Actual Use of Property

Section 6.1 of Part I of Schedule V exempts

"a supply of property that is

(a) land,

(b) a building, or that part of a building, that forms part of a residential complex or that consists solely of residential units, or

(c) a residential complex, made by way of lease, licence or similar arrangement for a lease interval (within the meaning assigned by subsection 136.1(1) of the Act) throughout which the lessee or any sublessee makes, or holds the property for the purpose of making, one or more supplies of the property or parts of the property and all or substantially all of those supplies

(d) are exempt supplies described by section 6 or 7, or

(e) are supplies that are made, or are reasonably expected to be made, to other lessees or sublessees described in this section."

Further, section 6 of Part I of Schedule V to the Act refers to a supply of real property made "for the purpose of its occupancy as a place of residence ".

Once the operator leases a residential unit on an exempt basis to provide longterm residential rents in a nursing home environment, the legislation requires (as per section 6.1 of Part I of Schedule V) that this action be reflected in the lease by the owner to the operator retroactively to the beginning of the lease interval. Hence, the owner will be required to prorate the GST charged on the rental payments between the value of that portion of the property that is used in commercial activities (i.e. the hotel) and the value of that portion of the property that is used in exempt activities (i.e. longterm residential rents).

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed or future amendments to the legislation may result in changes to our interpretation. These comments are not rulings and, in accordance with the guidelines set out in GST Memoranda Series (1.4), do not bind the Department with respect to a particular situation.

For your convenience, find enclosed, copy of GST Memoranda Series (1.4). If you need additional information, please feel free to contact us again at the above address, or myself at phone number (613) 952-9214.

Yours truly,

Doris Rist
A/Rulings Officer
Financial Institutions and Real Property
GST/HST Rulings and Interpretations

Encl.

Legal References:                   ETA

Reference:                               sec.136, Sched. VI6, VI6.1, HQR0000355,HQR0000300, HQR0000289,11950 domus 141, 118702 .c.n.755, 1 910807, 2 941117 and 961031. PP111.