Is a mortgage incentive taxable to a borrower financing a real estate purchase?

At issue

Real estate values have been rising at rates beyond historical norms over the last few years, especially in some major urban centres. Whether purchasers are seeking home ownership or investment opportunity, the usual need for mortgage financing is accentuated when property values rise so rapidly.

This is generally good news for financiers, but obviously the competition for borrowers can be stiff. The marketing minds at these institutions have come up with some innovative ways to attract the attention of purchasers, along with novel product features.

No doubt borrowers are appreciative of the competition that keeps interest rates in check, and for the perks they appear to be receiving. Appearance, however, is not necessarily reality, and a closer look at the tax implications of mortgage incentives will allow borrowers to better evaluate a given proposition.

Income Tax Act (ITA) sections

A few ITA sections have bearing on the discussion here, beginning with the basic rule of income in s.9, followed by some broad categories of income inclusions in s.12:

9. (1) Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.

…

12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable …

Among the forty or so categories in s.12, two paragraphs are of particular note: (c) interest, and (x) inducements and reimbursements.

2016-0681271E5 – Cash back amounts on renewed mortgages – March 21, 2017

In the situation brought before the CRA, a corporation receives cashback amounts from a bank at the time it renews mortgages relating to its rental properties. The cashbacks are subject to payback if certain events occur within 3 to 5 years. The questions posed are whether the cashback is taxable to the borrower, and whether any payback can be claimed as a deduction.

The CRA writer begins by ruling out the possibility of the cashback being an interest payment to the borrower. She then touches on the general rule under s.9(1), which may alone suffice, but rests the determination mainly on being an inducement pursuant to para.12(1)(x). The amount of the inducement would be treated as income for the tax year in which it is received.

As to any payback, if an inducement is included in income pursuant to para.12(1)(x), a related payback in a later tax year would entitle the taxpayer to claim a deduction under para.20(1)(hh) in that later time.

CRA Views 2015-0609071E5: Mortgage incentive – February 22, 2017

A credit union offered its members a bonus on deposits to a particular type of savings account, conditional on the funds being used as a down payment for a property purchase, with the mortgage being placed with the credit union. The credit union’s position is that, as there is already a flat interest rate on the account, the bonus should not be considered interest to the borrower.

As above, the CRA writer here also addresses whether the bonus may be interest, but does not come to a conclusion, and instead states that if the bonus does not meet that requirement then it may still be taxable under another ITA provision.

Both s.9(1) and s.12(1)(x) are dependent upon the taxpayer having income from “a business or property.” That is a question of fact, and “without a detailed review of the relevant facts and documentation, we are unable to provide a definitive response.”

Practice points

  1. The upfront rate on a mortgage is usually the main cost to a borrower, but other fees or concessions could increase or decrease that. An inducement in the form of an incentive is one such amount that can reduce the effective cost.
  2. Where an incentive is received by a borrower/taxpayer in the course of earning income from a business or property, such as a rental unit, the amount is likely a taxable amount.
  3. Where the borrower is not trying to earn income from the property, for example a family home, it is not clear whether the amount is taxable. While this leaves such individuals uncertain, at the same time it is conceivable that such amounts could be received non-taxable if the incentive program is carefully designed.

Tax effect if a charity returns a donated life insurance policy to a policyholder

At issue

Most people donate to charity by cash or its equivalent, whether on a one-off basis or as a periodic routine. This allows the donor to take an immediate tax benefit from the donation and for the charity to use funds for current needs. However, when longer term projects are contemplated, it may be desirable to establish a ‘planned giving’ arrangement, and that’s often when life insurance comes into consideration.

One way to do this is to name the charity as beneficiary on a policy owned by the donor. That person pays the annual premiums, with the tax benefit coming to the estate when the proceeds are paid at death. While the charity expects to eventually receive the money, the policyholder usually retains the ability to change the beneficiary, in which case the charity may ultimately get nothing.

For the charity’s greater certainty, the policy itself could be donated so the charity controls it. The donor receives tax credit for the value of the policy (if any) in the year of donation, plus year-to-year credit for any further premiums paid on the charity-owned policy. Of course, the donor may still have a change of heart, and though the charity could technically continue to carry the policy, that may be politically unpalatable. But is it even legally possible to return a policy, and if so then what are the tax implications for charity and donor?

CRA Guidance CG-016, Qualified donees – Consequences of returning donated property

The CRA’s guidance on this issue warns off the top that it is a legal issue whether a gift has been made and whether circumstances allow for a return by the charity. The guide focuses on the tax result on those “rare and unique circumstances” when there is a legal requirement for a charity to return a gift.

Assuming that the return of the property fits this test (or is believed to fit), an information return outlining the particulars must be filed with the CRA within 90 days. If the test is not met, this would likely be construed as a gift to a non-qualified donee, or the provision of an undue benefit. The penalty for such action is 105% of the value, or 110% on a repeat infraction, all the way up to revocation of registered status in egregious situations.

For a donor, there will be a reassessment of any year’s tax return related to the returned property, with any claimed charitable tax credits disallowed. This may be mitigated by the fact that the taxpayer is deemed not to have disposed of the property in the first place if the original property is returned. No mention is made of interest on related reduced/unpaid taxes, so presumably the normal rules apply.

CRA 2016-0630351E5 – Return of a gift

A taxpayer had gifted a whole life insurance policy to a charitable foundation in 1981, and now sought the return of that policy on the basis that a condition of the gift had not been fulfilled.

The foundation raises money to support a particular college, and the gift was made conditional on the proceeds being used to create a scholarship in a specific program. When the program was terminated, the taxpayer sought the return of the policy. The foundation was willing to comply, but on condition that the taxpayer obtain assurance from CRA that this would not negatively affect the foundation’s charitable status. This technical interpretation is the response to the taxpayer’s inquiry.

The writer on behalf of CRA repeats the relevant provisions of CG-016 (summarized above) with respect to the charity’s reporting obligations and the taxpayer’s exposure to reassessment.

However, it could not assist on the two key issues: whether the gift was subject to a condition, and whether the foundation could legally return the policy. The former requires a determination of the facts, and the latter a review of applicable legislation, both of which are outside the scope of a technical interpretation.

Practice points

  1. Donations to charity are almost invariably one-way transactions. Even if a donor and charity expect that the gift could be returned, governing legislation seldom allows that to occur.
  2. If a gift is to be conditional, that should be clearly documented between the donor and charity, including objective criteria regarding fulfilment of the condition. And if the condition is not fulfilled, it should be agreed what is (expected) to happen with the gift.
  3. Per CG-016, a taxpayer is subject to reassessment and disallowed tax credits claimed in preceding years. It is that much more uncertain in a situation like that outlined in letter 2016-0630351E5 with a timeline going back over 35 years, how statute-barred years would be treated. Whether or not those are included, with interest charges this could be quite costly.

Being an investment professional can influence tax treatment of your own investments

At issue

There is a fundamental concept in tax that determines how your investments are treated, being whether you are trading on ‘income account’ or on ‘capital account’.

It’s a concept that can cut both ways. On capital account, only half of gains are taxable, and only once realized; correspondingly, when losses are realized they can only be applied to reduce capital gains. On the other hand, income account treatment means full taxation on a year-to-year basis, while expenses in this arena are fully deductible in the year.

The ideal case for an investor would be to have all gains treated under capital account, and all expenses treated on a current/income account basis. As you might expect though, it’s not a matter of an investor simply choosing, though intention is part of the legal test.

What may surprise many people though, is that who you are – at least in terms of your professional/business profile – can influence how you are treated.

Income Tax Act (ITA) section 248 – Definitions

“business includes a profession, calling, trade, manufacture or undertaking of any kind whatever and … an adventure or concern in the nature of trade …”

Rajchgot v. the Queen, 2004 TCC 548

This is an oft-referenced authority on the legal test for income and capital treatment. The starting point is whether securities giving rise to a loss or gain are part of business activity (trading property) or investment activity (holding property). And the entrée into that analysis begins with ascertaining the taxpayer’s intention at the time of acquiring the securities.

Determining intention is understandably difficult, and is not helped much by a taxpayer’s statements, as those would be almost entirely self-serving. Intention then is derived by inquiring into and observing the taxpayer’s whole course of conduct. The framework for this analysis is arranged under the following headings:

  • Frequency of transactions
  • Duration of holdings
  • Nature and quantity of securities held
  • Time spent on the activity
  • Financing
  • Particular knowledge possessed by the individual

Foote v. the Queen, 2017 TCC 61 (released April 21, 2017)

According to the case fact summary, Mr. Foote had a sense that the markets had bottomed out in March 2009. Over the course of that year, he carried out 38 purchase transactions with an aggregate value of about $2.5 million, and generated about $3.0 million from 50 sale transactions. His total gain was about 23%. Mr. Foote reported the net result as capital gains in his 2009 income tax return. The Canada Revenue Agency (CRA) reassessed the amount as income, and Mr. Foote appealed to the Tax Court of Canada.

Mr. Foote had been in the investment industry for over 25 years, at the time working as head of institutional trading at a major investment dealer. In his role, he did not directly trade securities, but did oversee others who traded. On a personal level, he testified that his investment strategy had always been to invest in diversified securities he felt had the potential for 30% returns over a reasonable time frame.

The judge reviewed the facts under the Rajchgot heads of analysis. Trade frequency had tripled in 2009 relative to prior years, and hold periods averaged just 50 days, with some securities bought and sold within the same week. Despite not technically being a trader, his position “in common parlance and as generally described in the markets” nonetheless fell into that category. While acknowledging that the activities did not amount to “carrying on a business of trading securities”, the judge found that they handily met the requirements of “an adventure or concern in the nature of trade” under the ITA s.248 definition of business. Accordingly, the appropriate treatment of the gains was held to be income.

Practice points

  1. Tax treatment of securities trading can vary based on the subject matter traded, the manner of trading, and the individual carrying out the trades. Frequent trades and short holding periods tend toward full income inclusion, as opposed to capital gains treatment.
  2. Working within the investment industry does not invariably result in income treatment. For example, being the vice-president of human resources or information technology for a securities dealer would not in itself suffice. However, where a person’s job is integral to the business function of trading securities, that fact is far more influential in arriving at a determination of income treatment. And it is not a sufficient reply to merely show that the individual was not trading on insider-type information.
  3. Still, it remains possible for even a full-time professional trader to be trading on capital account in his or her personal affairs, if the facts can support that conclusion.