This article outlines some of the more common instances where land transfer may be payable in circumstances where parties may not normally anticipate this particular cost.
Anyone who has purchased real estate in Ontario will have experienced the effects of the Land Transfer Tax Act, R.S.O. 1990, C.L.6 (the "Act"). The current tax rate for commercial property is approximately 1.5% based on a staggered formula (but can be double that if the City of Toronto levy also applies) and a higher rate may apply in the case of residential properties. For the most part, the Act is relatively well understood and cost effective to administer from the standpoint of the government. If a transaction requires the registration of an instrument on title, appropriate statements with the effect of an affidavit must be provided regarding the details of the transaction and the value of consideration payable for such conveyance. Tax payable based on such statements must then be paid to register the instrument. Although after 1989 some aspects of the administration became more complicated, when tax became payable on unregistered dispositions of beneficial interests in land, the reporting, collection and assessment process required for such transactions is administered by the Ministry of Revenue separately from the title registration process. However, as with all taxing statutes there are occasional disputes, and there can be instances where tax is payable or assessed based on legislative provisions or interpretations by the Ministry staff which may be surprising to a tax payer.
Most issues arise due to the wide drafting of Act. A key term is the definition of "value of the consideration", which is the base for calculation of taxation in the Act. This sets out a list of specific sub-clauses starting with a generally worded clause followed by other sub-clauses which deal with specific fact situations. Both the list of more broadly worded and specific aspects of the definition is prefaced with the statement that the value of consideration shall "include" those items. The broadest sub-clause in the definition provides that the value of consideration includes, among other items, the amount expressed in money of any consideration given or to be given for the conveyance by or on behalf of the transferee, and the value expressed in money of any liability assumed or undertaken by or on behalf of the transferee as part of the arrangement relating to the conveyance.
To take a simple example of a house purchase where the buyer agrees to assume an existing mortgage, this language therefore brings into the tax base both the cash component of the purchase price being paid to the vendor, and the principal and interest accruing to the closing date upon the existing charge/mortgage registered against the property being purchased. However, there are more subtle factual situations which the Act clearly taxes, or the Ministry of Revenue has interpreted it to tax. These should be borne in mind when projecting transaction related costs, particularly since some of these costs may only arise years after the closing due to a post transaction audit by the Ministry staff. Common examples include:
(a) tied sales and construction contracts — in the situation where a property is being sold (or resold) and the agreement requires or is conditional on the vendor and purchaser entering in to a separate agreement under which the purchaser retains the vendor (or another entity) to construct or expand/renovate a building on the real property, the cost of the construction contract is considered to be a liability assumed as part of the conveyance relating to the arrangement, and land transfer tax is payable on such cost at the closing;
(b) presently unknown or contingent consideration — where an initial base price is payable for real property e.g. land which is zoned for lower density at closing, but the agreement provides that future consideration (in whatever form) may become payable in the event the purchaser and/or vendor are successful in achieving agreed criteria such as increased density or other targets, tax may be payable on the value of such future payments. Since the amount of such payment is not likely to be reliably predictable at the time the transaction is closed, in lieu of payment of tax on an arbitrary amount the situation can be dealt with by way of a purchaser’s undertaking to the Ministry of Revenue to report and pay tax on such amount as and when this becomes known;
(c) environmental liabilities. This is an emerging area where the issue may arise when the agreement provides for a purchaser to undertake certain environmental remediation work in connection with the real property. Where the agreement contains express language to this effect, the Ministry of Revenue may conduct an audit and assess tax on some amount. This leads to interesting questions such as how such liability should be valued. A related issue is whether tax should also be paid on the value of other contractual or statutory liabilities associated with ownership of real estate, such as under development agreements or site plan agreements. Other scenarios of this nature can be envisioned due to the very broad statutory language in the statute; and
(d) variations by contract of "normal" allocation of real property liabilities as between co-owners. An example of this is the situation where a co-ownership is structured with one party responsible to pay a portion of the cost of debt servicing of existing mortgages affecting the property different from the amount applicable to its proportionate interest. Unless the mortgagee expressly agrees to limit the liability of such party to this adjusted percentage in appropriate documentation, the Ministry of Revenue may well take the position that tax is payable on the basis of the proportionate share interest in the property acquired by the purchaser, notwithstanding the agreement as between the parties to allocate the economic costs in a different manner, and the factual history that may support that agreement.
A number of other issues may arise in corporate reorganizations due to differences in the approach taken in the Act and/or interpretations of the Act by the Ministry of Revenue which are different from those given to such other taxing statutes, in particular the Income Tax Act. In many such instances, the issue of whether tax may be payable under the Act arises even though a transfer/deed is not registered on title due to the provision of the Act that taxes unregistered dispositions of beneficial interests. Some common examples of issues in this area are as follows:
(i) corporate affiliate rollovers — the automatic tax free rollover under the Income Tax Act is not mirrored in the Act and, strictly speaking, is actually not available, although there is a deferral and tax cancellation process which produces much the same economic result. However, this requires an application to the Ministry of Revenue, the production of considerable background material and a letter of credit to the Ministry, and then a three year conditional period must elapse before the tax is cancelled and letter of credit returned. Given the cost of the letter of credit and the documentation required, the cost savings in land transfer tax should be weighed against those associated with the deferral process. A significant complication also exists in the statutory requirement that the rollover disposition be by way of unregistered conveyance, so the registration on title of any evidence of the disposition between the corporate affiliates is prohibited. This requires careful consideration of the nature and timing of any steps in the reorganization, and review of any instruments, including security for financing, required to be registered on title in any such corporate reorganization;
(ii) transfer of partnership interests — the Ministry of Revenue has always taken the position that a partnership is not a separate legal entity, and accordingly that each transfer of an interest in a partnership which owns land will be potentially subject to land transfer tax. Although there is a regulation which grants an exemption for "de minimus" transfers of up to 5% in each partnership year this position is quite different from that under the Income Tax Act, and must be considered when structuring such transactions. There is no difference in this treatment as between limited and general partnerships; and
(iii) "butterfly" transactions under the Income Tax Act. The treatment available under the Income Tax Act for these types of sophisticated asset division reorganizations is not always available in the context of land transfer tax. The Act treats all these transactions as taxable at first instance, but a regulation gives an exemption in particular situations, which does not capture all the possible variations of this transaction. A careful analysis of the transaction structure must be undertaken to determine if the exemption allowed by the regulation is available.
In closing, the examples above represent some of the areas which in the writer’s experience may become problematic in dealings with the Act. It is hoped that this list will act as a reminder to our clients that unforeseen surprises can and do arise even in a commonly used statute such as the Act, and should be borne in mind in drafting documentation and structuring transactions. To use an old admonition, an ounce of prevention can be worth a pound of cure.