Factual distinction between business and property income for corporation (p. 32:4)
In the case of a corporation whose sole activity is the ownership of such property, there is a presumption that a corporation is formed for the purpose of carrying on business; accordingly, where the corporation has only one activity or investment—regardless of its nature—the corporation may be held to be carrying on a business in respect of such single activity or investment. [Footnote 17: Burri v. The Queen, 85 DTC 5287 (FCTD) … . See also Matlas SA v. The Queen, 94 DTC 1586 (TCC) and Canadian Marconi v. R, [1986] 2 S.C.R. 522. See also Canemro Anstalt v. La Sous-Ministre du Revenu de la Province de Québec (1987), court file no. 500-02-020973-850 (QC Prov. Ct.), where in circumstances quite similar to those in Burri, a Quebec court found that apartment building operations owned by a foreign corporation gave rise to income from business and not from property but without, per se, relying on the corporate presumption. See also Étoile Immobilière SA v. The Queen, 92 DTC 1984 (TCC), in which a corporate taxpayer was found to be carrying on business in respect of a residential property notwithstanding that a third-party manager was engaged to manage the property. See also Valec SA v. The Queen, 98 DTC 1266 (TCC), in which the court reaffirmed the presumption in Burri and Marconi with respect to rental income earned by a non-resident corporation, but ultimately did not rely on that presumption in finding that the rental income constituted business income. Also note the case of Malenfant v. The Queen, 92 DTC 2081 (TCC), in which the court found that income from the operation of a hotel constituted income from property (that is rent), rather than income from services. The CRA does not necessarily agree with this decision.] The Canada Revenue Agency (CRA) will typically look at the level of services rendered. Where the services are basic and typical of what landlords of similar properties would provide, the CRA will generally take the position that the income constitutes property income. [Footnote 18 See IT-420R3 … at paragraph 12 and IT-434R … at paragraphs 2-7.] Where property is leased to a single tenant on a triple net lease basis, the CRA will generally consider that the income from such property is also property income.
Tax computation where s. 216(1) election (p. 32-6)
Where a section 216 election is made, income is computed as it is (in the manner set out above) to determine taxable income for business property, with one exception: losses of other years may not be applied in determining the taxable income. In such circumstances, a corporate investor should avoid claiming capital cost allowance (depreciation) in excess of the amounts required to reduce rental income to nil. It may also be possible to match revenues and expenses by filing on a cash basis. In addition, expenses that would otherwise result in a loss should be capitalized where possible. In the case of non-business property owned by a non-resident investor that makes a section 216 election, taxes arise under the Act at the statutory federal rate of 25 percent (on the basis that the 10 percent provincial abatement is not available, but the section 123.4 rate reduction applies) applicable to the taxable income in the case of corporations, and at rates up to roughly 49 percent in the case of individuals. There is no liability for provincial tax (except in Quebec), and there is no application of branch tax for corporations.
Potential preference for using a Canadian corporation where business income (p. 32-13)
[A] non-resident investor that anticipates earning business income from an investment in Canadian real estate should consider making the investment through a Canadian-resident corporation to avoid having the non-resident itself file annual Canadian income tax returns (particularly where multiple non-resident investors are involved in making the investment, either as joint venturers or through a fiscally transparent entity, such as a partnership), and pay Canadian withholding tax on dividend distributions at a predetermined reduced tax treaty rate instead of branch tax (where the non-resident is a foreign corporation), which applies whether distributions are made or not and, in certain cases, may not benefit from an otherwise available reduced tax treaty rate (such as, for example, for USLLCs with individual members).
Potential advantage of s 116 election (p. 32:14)
If the non-resident investor makes a section 216 election for the non-resident corporation to be taxed under part I as if it were a resident of Canada, the applicable income tax rate to the non-resident corporation’s net rental income (and taxable capital gains) will be the same as that which would apply to a resident of a tax treaty jurisdiction and, unlike when a Canadian corporation is used to make the investment, distributions made by the non-resident corporation will generally not be subject to Canadian dividend withholding tax or branch tax, nor will any interest paid on intercompany debt be subject to Canadian withholding tax.
Potential double taxation re rental properties in Quebec (p. 32:17-18)
[T]he deeming rule in section 12(2) of the Q TA does not have an equivalent provision in the federal regulations. Section 12(2) deems a corporation to have “an establishment in each province of Canada in which an immovable owned by the corporation and used principally for the purpose of earning or producing gross revenue that is rent is situated.” This rule [applies] … whether such income is passive in nature or constitutes business income. …
If a non-resident corporation earning passive rental income were to make an election under subsection 216(1), the rental income would become subject to federal income tax under part I as though the non-resident corporation were a resident of Canada. However, the fact that the Act does not contain a deeming provision that is equivalent to section 12(2) of the QTA results in the non-resident corporation not being considered to have any “taxable income earned in a province” for the purposes of subsection 124(1) of the Act, and therefore the non-resident corporation will not be entitled to the 10 percent federal abatement. This generally is not problematic for rental income earned from real property situated in provinces other than Quebec, since there is not any provincial income tax applicable to such income, and therefore the federal abatement is not necessary to avoid double taxation. However, since a non-resident corporation earning rental income from real property situated in Quebec will be deemed to have an establishment in Quebec under section 12(2) of the QTA, it is subject to income tax in Quebec at a rate of 11.6 percent. Since the aforementioned federal abatement under subsection 124(1) of the Act is not available, the result is that the non-resident corporation is subject to a 36.6 percent tax rate. …
[W]here a non-resident disposes of real estate situated in Quebec, which constitutes “taxable Quebec property” (TQP) (as defined in section 1094 of the QTA) as well as “taxable Canadian property” … the absence of an equivalent provision to section 12(2) of the QTA in the Income Tax Regulations results in a certain degree of double taxation … .
Use of headlease structure where underlying Canadian income is business income (pp. 32:29-30)
[I]f instead of operating the hotel or the assisted-living facility directly, the non-resident investor leased the property to a separate Canadian operating corporation (which may or may not be a wholly owned subsidiary of the non-resident investor) on a triple net basis (that is, under a “head lease”), the non-resident investor would effectively be earning passive property income under the head lease instead of income from the operation of a business. This would allow the non-resident investor to make an election pursuant to section 216 for the rental income to be taxed under part I, as though the non-resident investor were a Canadian resident, at a rate of 25 percent. Also, distributions of net after-tax income would not be subject to Canadian withholding tax or branch tax, and interest on intercompany debt should, in most circumstances, also be free of Canadian withholding tax. The business income earned by the Canadian operating corporation would, however, be taxed as business income in the manner described above, but in many cases the amount of net business income earned by the operating corporation would be significantly less than the amount of net rent earned under the head lease. Where the operating company is a Canadian-resident corporation and a wholly owned subsidiary of the non-resident investor, the terms and conditions of the head lease will need to respect the arm’s-length principle … .
This structure is also often used for other types of commercial properties (for example, office space or shopping centres) where there is some uncertainty as to whether the income generated from the properties is passive rental income or business income … .
ARQ position that shares with no connection to Quebec can be taxable Quebec property (pp. 32:20-21)
[I]n certain circumstances shares of a corporation (whether Canadian or foreign) could constitute TQP even when the corporation in question has no assets or property in, or any other connection to, the province of Quebec. Indeed, the definition of TQP includes
(c) a share of the capital stock of a corporation (other than a mutual fund corporation) that is not listed on a designated stock exchange, . . . if, at any time during the 60-month period that ends at the particular time, more than 50 percent of the fair market value of the share . . . was derived directly or indirectly from one or any combination of (i) an immovable property situated in Quebec, (ii) a Canadian resource property, (iii) a timber resource property, and (iv) a right in or an option in respect of a property described in any of subparagraphs i to iii, whether or not the property exists.
For these purposes, “Canadian resource property” is defined in section 370(b) of the QTA [by reference to] … a mineral resource in Canada …. One example is where a foreign corporation owns shares of a Canadian corporation that has as its only asset mineral exploration rights situated in a province other than Quebec (say, Alberta). On a literal reading of the relevant dispositions of the Q TA, these shares would constitute TQP … The result would be the same where the Canadian corporation was instead a foreign corporation. While it may be arguable that Q TA section 1094(c)(ii), as currently drafted, exceeds Quebec’s powers of taxation, Revenu Québec is aware of this particular interpretation of the section, but it has not indicated that it would adopt a narrower interpretation so as to avoid the application of the TQP rules to a scenario such as the one described above. [Footnote 102 … document no. 07-010503 … .].
Quebec taxation of income from specified immovable property
[N[on-resident inter vivos trusts that own immovable property in Quebec and that earn rental income from that property (that is, passive rental income that does not constitute business income earned through an establishment in Quebec) are also subject to provincial tax in Quebec. This is a result of amendments made to the QTA in 2012. Prior to the amendments, property income of non-resident inter vivos trusts from real estate in Quebec (to the extent that it did not constitute business income) was subject only to the highest marginal federal income tax rate applicable to individuals, plus an additional surtax (which is meant to approximate provincial tax) for a combined rate of 48.84 percent. Since the amendments came into force, a “specified trust” is subject to an additional 4.47 percent provincial tax on property income from “specified immovable property” (defined as an immovable property situated in the province of Quebec that is used mainly for the purpose of earning or producing gross revenue that constitutes rent). The combined 53.31 percent tax rate corresponds to the highest combined income tax rate applicable to an individual in Quebec. Property income derived from the rental of specified immovable properties must be computed separately from income from any other sources of a specified trust. …
Double taxation on a disposition of specified immovable property
On a disposition of a “specified immovable property,” [by] a non-resident inter vivos trust … the taxable portion of the capital gain (and recaptured depreciation, if any) will be subject to federal income tax and the surtax at a combined rate of 48.84 percent (resulting in an effective tax rate of 24.42 per-cent on the capital gain). However, the taxable portion of the capital gain will also separately be subject to Quebec income tax since a specified immovable property constitutes TQP. The applicable income tax rate is currently 25.75 per-cent (for an effective rate of 12.875 percent on the capital gain), resulting in an effective combined federal and provincial rate of 37.30 percent. Compare this to the effective income tax on the gain realized by a trust resident in Quebec, which would be 26.66 percent.