Partnerships are not always what they seem…a common question arising around the new Underused Housing Tax
Partnerships are only sometimes straightforward, especially regarding the new Underused Housing Tax (UHT). Many clients have been asking whether a married couple or common-law spouses (herein, “the couple”) who jointly own a residential rental property or Airbnb property should be considered a “partnership” for UHT purposes. This is important because being classified as a partnership would require them to file a UHT return.
The concern arises from whether the couple qualifies as “Excluded Owners,” as defined in the legislation and publications produced by the Canada Revenue Agency (CRA). Excluded Owners are not required to file UHT returns, but individuals who own residential real estate as part of a partnership are not considered Excluded Owners.
Simply put, if a Canadian couple, both citizens, jointly own a property that is not their primary residence, are they considered a partnership? Furthermore, even if only one spouse is listed on the property’s title, they may still be considered a partner in a partnership. In that case, both individuals would each need to file a UHT return annually and may be able to claim an exemption to avoid paying the 1% tax on the property’s value.
The term “partnership” is not defined in the UHT legislation. However, the CRA has provided guidance regarding partnerships for income tax and GST/HST purposes. Previous court cases have also shed light on what constitutes a partnership. For example, in the Bains vs. the Queen case of 2005, a husband and wife receiving passive income from a commercial rental property were not considered partners in a partnership for GST/HST purposes. The court focused on the passive nature of the income when making this determination.
This case resembles typical arrangements where couples jointly own one or more rental properties. Residential rentals are typically more passive than commercial properties, which suggests that such situations should not be considered partnerships. However, short-term rentals like Airbnb, which involve active business income, may be treated differently, and a couple may be seen as partners in a partnership.
It’s worth noting that income tax cases are decided by the Supreme Court of Canada that address partnership existence. However, none of these cases closely match the typical situations of couples owning residential property together. The established common law test for partnership existence requires three factors: the presence of a business, the business being carried on jointly, and the intention to make a profit.
In the Bains case, the couple met the last two criteria but not the first one because their income came from a passive source (commercial rental property), and arguably, the court considered them not to be “in business” together. However, both spouses managed and maintained the property to make a profit. Importantly, it’s okay to make a profit currently, but having a future intention to make a profit is sufficient. So, if a jointly owned residential rental property experiences losses or is not expected to generate gains for a while, it doesn’t mean that a partnership doesn’t exist. Therefore, assuming no partnership and not filing a UHT return based on losses alone could be an incorrect presumption.
What should you do now?
Even if your situation resembles the Bains case, there’s no guarantee that the CRA will agree, despite the support provided by the Bains decision. Until the CRA publishes further guidance, they might argue that both spouses are partners in a partnership, requiring each to file a UHT return for their jointly owned residential property. In this case, they would not be considered Excluded Owners as of December 31 of each reporting year.
However, most situations should, at a minimum, qualify for an exemption available to members of a “specified Canadian partnership.” This exemption applies to a partnership where each partner is an Excluded Owner, including Canadian citizens or permanent residents who are considered Excluded Owners solely because they hold residential property as partners. This rule may seem confusing, but the CRA provides an example of this situation in their UHT notice on specified Canadian partnership exemptions.
Given the lack of specific UHT guidance from the CRA regarding partners and partnerships, it’s advisable to file an annual UHT return and claim the exemption under the specified Canadian partnership rule (or other available exemptions) discussed above, just to be cautious. This exemption would prevent each individual from paying the 1% tax. However, it’s crucial to file the annual return by April 30 (October 31, 2023, for the 2022 reporting year) following the reporting year to avoid a penalty of $5,000 per individual.
Remember that other potential exemptions depend on your specific situation. For instance, certain vacation properties depending on the owners’ annual usage, properties unsuitable for year-round use, inaccessible during some seasons (like winter), or uninhabitable for part of the year, may qualify as exemptions. This is typically the most common exemption if your property is a long-term residential rental with an arm’s length lease agreement. Nonetheless, you must still file the return and claim the applicable exemption(s) on the UHT return.
If you would like to engage us for a deeper discussion or need assistance in filing your UHT return before October 2023 on your situation, don’t hesitate to contact us for a consultation.