Taxpayers will always try and pay the lowest amount of taxes possible. That is why the difference between business income, and capital gains is so important. Business income is taxable on the full amount, where only half of the capital gain is taxable. This alone creates a large incentive for taxpayers to frame transactions as capital gains, rather than business income.
What is a Capital Gain?
Where a taxpayer sells capital property, the amount of money earned from the sale is known as a capital gain. If the sale is done at a loss, this is a capital loss. Capital property is property that produces long term benefits. The typical example is that a tree’s fruit, if sold, would be business income, but if you sell the tree, that is capital property and results in a capital gain.
Adventure in the Nature of Trade
If a taxpayer is in the business of buying and selling capital property, the Canada Revenue Agency (“CRA”) will tell that taxpayer that those sales are an adventure in the nature of trade. What this means is even though the taxpayer is selling capital property, a capital gain is not earned. Rather, the sale produces business income and the full amount is subject to taxation. If the CRA tells you that you are in an adventure in the nature of trade, they are stating that you are running a business and not entitled to declare the profits as capital gains.
For the sale of real estate, the CRA relies on the primary, and secondary intention of the taxpayer in order to determine whether the sale results in business income, or capital gains. If the taxpayers intention is to re-sell the property, then that is considered a business, and the sale would result in business income.
CRA’s publication on the matter provides a number of factors that are taken into consideration:
- Taxpayer’s intention at the time of purchase;
- Feasibility of that intention;
- What use may the real estate be put to;
- Was taxpayer’s intention carried out;
- Did the intention change post purchase;
- Is the taxpayer employed in a similar industry;
- Was borrowed money used;
- Length of time the property was held by the taxpayer;
- Did others own the property as well;
- Taxpayer’s actual conduct;
- Factors which led to the sale; and
- Evidence of taxpayer’s extensive dealings in real estate.
Principal Residence Exemption
If the sale of a home results in capital gains, taxpayers may then use the principal residence exemption to shelter the gain from any taxes owing. This is the reason why so many taxpayers attempt to have the sale of their homes declared capital gains.
Taxpayers in Construction Industry or Real Estate
Many taxpayers who frequently buy and sell principal residences, or who are employed in a similar business (construction, real estate agents, etc.) will move into a home, possibly renovate, and then sell the home at a profit. Taxpayers believe that since they lived in the home, they should be eligible for the principal residence exemption. The CRA disagrees and will usually claim taxpayers who choose to buy and sell homes in this manner are running a business, and the whole gain from the sale should be declared business income. The reason for this is simple, it means that the gain from the sale of a home goes from non-taxable, to completely taxable. This could result in hundreds of thousands of dollars, sometimes millions, that the CRA would otherwise not been eligible to collect.
If the CRA determines that taxpayers should have declared business income, rather than a capital gain, they will often impose gross negligence penalties as well. To make matters even worse, if CRA decides that a taxpayer is running a business, then they will want the full amount of GST/HST that should have been charged on the sale of the home.
If you have bought and sold any property and think it could be treated as business income, you should look into the voluntary disclosures program. If you are being audited for the sale of property, call us today to see how we can help!
Canada Safeway Limited v. Her Majesty the Queen, 2008 FCA 24 – Primary and Secondary Intention
Friesen v. Canada, 1995 SCR 103 – Capital Property or Business Income
Belcourt Properties Inc. v. The Queen, 2014 TCC 208 – Unsolicited Offers
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.