Managing The Audit of Real Estate Transactions

Published by Greg DelBigio, Q.C.

It used to be that the favorite topic of conversation in Vancouver, and then more recently in Toronto was the cost of real estate. There was unending speculation on how high the prices might go and whether the party would ever end.

Rather unsurprisingly, as prices rose the conversation eventually shifted to the unaffordability of real estate in these markets and there have now been questions about who was responsible for inflating the real estate prices, how to control the prices and there were further questions about whether buyers and sellers were complying with their tax obligations. It is this latter question that might have been of greatest interest to the audit division of CRA.

A recent story in the Globe and Mail focused upon the apparent lack of tax oversight in the Vancouver real estate market and a statement from B.C.’s finance minister called on the CRA to enforce the law “diligently”.  The BC Finance Minister’s office has also indicated that the Ministry is working with CRA to assist with lifestyle audits by providing property transfer information to CRA.

Against this background, the CRA has announced that it has launched a review of real estate transactions in B.C.  We learned that the CRA had already been focusing on B.C.’s real estate market and now plans to add 70 auditors to the region. In late September CRA published “How Does the Canada Revenue Agency address non-compliance in the real estate sector?” In this publication, CRA advises that it has “doubled its level of effort focused on the BC real estate sector” and that it has also “started a review of 500 high dollar value real estate transactions in British Columbia.”

The five areas of “compliance risk” that have been identified by CRA are:

  1. Questionable sources of funds. As stated in the report, “[t]he acquisition of expensive assets, such as a high-end home, without an obvious income source, can be an indicator of potential unreported income earned from legal or illegal sources of income.”
  2. Property flipping.
  3. Unreported goods and services tax/harmonized sales tax on the sale of a new or substantially-renovated property/ GST/HST new housing rebate.
  4. Unreported capital gains.
  5. Unreported worldwide income.

We expect to see more, and more aggressive real estate audits being conducted by CRA for both income tax and GST and auditors will likely examine issues such as:

  1. Whether the disposed property qualifies for the principal residence exemption. If the CRA is not satisfied that the property has met all the requirements of the exemption, part or all of the exemption will be denied.
  1. Whether the gain realized on the disposition of real property is a capital gain (50% taxable) or business income (100% taxable). The distinction of capital gain from business income is often not straightforward and prone to challenge.
  1. Whether income has been reported in respect of an assignment of contract for the purchase of real property. If income has been reported, there may be a further issue of whether the gain from the assignment of contract is capital gain (50% taxable) or business income (100% taxable).
  1. Whether the buyer has complied with the withholding requirements in respect of an acquisition of real property from a non-resident. If no clearance certificate has been obtained pursuant to section 116 of the Income Tax Act, the buyer may be liable for 25% of the purchase price that should have been withheld and remitted to the CRA.
  1. Whether GST has been collected and remitted on the sale of new or substantially renovated housing. If a builder has leased or moved into to a new or substantially renovated home, the builder may be liable to pay GST on the fair market value of the home, including the land value.
  1. In addition to tax issues that directly apply to real property transactions, the focus of an audit might also turn to a taxpayer’s worldwide income. In those cases, the CRA might look into whether the taxpayer’s lifestyle is being funded by unreported income from a foreign source.

If CRA concludes that a taxpayer has underreported income or has failed to collect or remit GST, reassessments will be issued to the taxpayer in respect of the taxes owing and applicable penalties.

Where a taxpayer has knowingly or under circumstances amounting to gross negligence made a false statement or omission in reporting of tax, the penalty will generally be 50% of the underreported amount of income tax and 25% of the underreported amount of GST.

In some scenarios CRA auditors might also refer a file for criminal investigation and prosecution for tax evasion. A prosecution could be based, at least in part, upon the information provided to an auditor and a conviction would result in a fine, potentially jail and a record of criminal conviction.

The recent CRA publication advises that some taxpayers “who have made a mistake or left out details about income” might be eligible for the voluntary disclosure program. Having regard to the potentially severe consequences of a real estate audit, we agree that those who have questions or uncertainty about their compliance should seek advice in respect of their eligibility for that program.

The same publication offers people the opportunity, and encourages participation in the Informant Leads Program which is a program where suspected cases of non-compliance can be confidentially reported upon. It may be anticipated that at least some will accept this invitation  and this will provide CRA with leads for yet more audits.

The CRA’s message is simple and straightforward: they are actively looking for audit leads,  there will be more audits and, where appropriate, taxpayers will be reassessed for tax, interest and penalties and possibly referred for criminal prosecution for tax evasion.

Our message is equally straightforward. For some, a real estate audit can have significant financial and, in some instances, penal consequences and these risks must identified and carefully managed. Where these risks exist, the availability of the voluntary disclosure program should be considered and should be considered before it is too late to do so.

This article was co-written with Ken Jiang and Noah Sarna.