Tax Mailbag: AOC Rules & HST on STR
Buying a business in Canada isn’t just as simple as offering money and taking over the business. There are plenty of things to go over before buying a business in terms of due diligence, valuation, legal and tax aspects. I want to talk about the tax aspect of buying a business in Canada.
Under Canadian income tax rules, when someone acquires control of a business (called Acquisition of Control, AOC for short), certain tax triggers are set off. These are called the acquisition of control rules. Control is based on legal (de jure) control. Which means 51% or more. This is not the same as a change in control.
A change of control is not always an AOC but an AOC is always a change in control
Clear as mud?
Let me try to explain with an example. If Shareholder A owns 100% of ACo. and he decides to sell 45% to BCo and 10% to CCo., there has been a change in control as Shareholder A has gone from 100% to 45%. There has been no acquisition of control because no one shareholder controls the company. If BCo and CCo are acting in concert there could be a potential acquisition of control but for the purposes of this example let’s ignore that.
If Shareholder A sells down to 20% and BCo buys 60% and CCo buys the other 20%, there has been an acquisition of control as BCo now owns greater than 51% of ACo.
The tax rules following an acquisition of control are:
Deemed year end
The business being taken over is deemed to have their year ended on the date prior to the AOC. If the purchase date is July 1, then the year is deemed to have ended on June 30. If the company’s fiscal year is January 1 – December 31, there will have to be a stub period of January 1 – June 30 that will result in financial statements and tax returns done for this stub period. The company can then choose a new year end if it wishes within 53 weeks.
CCA and small business deduction prorated
Tax depreciation and the small business deduction will be prorated for the stub period year end.
Shareholder loans accelerated
The rules of shareholder loans make it that if there is an amount due from a shareholder over two balance sheet dates, the shareholder must go back and amend their tax return to include the amount. An AOC will speed up the repayment of that shareholder loan because of the deemed year end. If a shareholder owes a company $100K on December 31, 2022 and decides to sell on March 1, 2023, instead of having the full year up to December 31, 2023 to pay the amount back, he either has to March 1 or must include it in his income if it is still outstanding on March 1, 2023.
Carryforwards/backs
If the company has any loss caryforwards that can be carried forward, they will lose a year that they can be used when an AOC occurs.
Charitable donations
Any charitable donation balance outstanding cannot be carried forward.
Non-depreciable/capital property & capital losses
Any marketable securities or land that are sitting in a loss is deemed to be taken. If a stock you bought at $100 is now at $50 when the acquisition occurs, it is written down to $50. This $50 loss, that is now a capital loss, must be used in that tax year end because capital losses cannot be transferred once an acquisition of control takes place. Meaning any capital loss balance will expire! This is a very important point to emphasize. The new ACB of the stock would be $50 because that is the current FMV.
If the asset FMV is greater than the cost base of the property, the accrued gain can be carried forward and does not have to be recognized. But if the company has capital losses that are expiring, you can make an election to trigger a gain and use up your capital losses. This would also increase your adjusted cost base at the same time going forward which would shield more taxes when you ultimately go to sell.
Depreciable property
All depreciable property is written up or down to FMV. If the UCC (remaining balance of tax depreciation) exceeds the FMV, the difference is deemed to be tax depreciation taken in the year. The UCC going forward will be the FMV of the property at the time of acquisition of control.
Non-capital losses
Any balance of non-capital losses can be carried forward provided certain rules are met: 1) the business that created the loss is continuing to be carried on, 2) the business has a reasonable expectation of profit, 3) the losses are used to offset income from a same or similar business. You can’t be in the farming business and purchase a laundromat that has non-capital losses and use those losses against your farming income. A lot of people forget that “same or similar business” rule for non-capital losses. But if that farming business buys another non-profitable farming business that has losses, they can use those losses to shield income against their current profitable business.
The reasons all of these rules are put into place is to prevent the trading of loss companies to shield income. It stops a company sitting on a large capital gain to buy a company with large amounts of capital losses and then use those losses to shield the gain. Or companies in different industries buying each other and shielding income.
Some other items to keep in mind is these acquisition of control rules do not occur if the buy/sell/transfer is between related persons. The refundable dividend tax on hand account and capital dividend account is carried through unless the private corporation is acquired by a public corporation. Any accrued loss that is deemed realized because of the acquisition of control will effect the capital dividend account and therefore proper planning needs to be in place as to whether it makes sense to pay a capital dividend prior to the acquisition of control.
HST on STR?
There was a recent ruling in the Tax Court of Canada this past week that ruled property owners who are using property for short term rentals (STR) using AirBnb or other sites will need to charge HST of 13% on the sale of their property. This article (see here) in the Toronto Star does a good job of summarizing the opinion.
This rule is not really new but having it brought through the courts and into the spotlight makes more Canadians aware that it exists and they could be liable for it. On top of that, you need to be aware that there is also a self-assess rule that if you want to convert the STR property back into residential for living in or longer term leasing, you need to self-assess HST on the property. What this means is that you, the property owner, charge yourself 13% of the value of the house and pay CRA the HST amount. This could obviously cost a lot of money with where real estate prices transact now. It might make more sense to just stay a STR. But towns and cities are starting to ban certain zones in their districts from operating as a STR which would leave the owner of the property no choice but to convert back and pay the HST.
If you meet the following rule you should speak to a tax accountant, as you’ll most likely owe HST upon sale or converting:
Where more than 50% of the property is not used as the vendor’s place of residence
AND
All or substantially all (90% or more) of the property rentals are for periods of less than 60 days.
For more information about these rules you can visit this page on CRA.
There might be a way around paying of HST if both the seller and buyer are registered for HST. By filing a joint election under section 167 of the Excise Tax Act, the sale of the property can be a zero-rated supply and therefore no HST would have to be paid. You would have to double check that you meet all the requirements for filing this election.
DISCLAIMER: The articles posted on TaxCrunch should not be considered specific advice to anyone readying. Please reach out to a professional advisor to seek guidance on any issues mentioned in this post before acting upon anything written here. All posts are time sensitive to what is law at the time written and are subject to changes in legislation.