Here is the situation. You have made the decision to build a nice, new winery building on your property. Your winery business is doing well and can support the capital cost of the building. You own your property personally and have incorporated a company to run the winery business. You want to use your corporate profits earned inside your company to help pay for the cost and/or repay the loan associated with the building. As a result, you have the company construct and own the new building. Sounds okay so far? Unfortunately not. If you don’t structure this type of arrangement correctly you can walk right into a tax nightmare.
There are various provisions in the Income Tax Act that reinforce the concept that if a shareholder of a company receives any kind of benefit from the company then the value of the benefit needs to be included in his or her personal income, and is taxed. In the situation described above, a winery corporation has constructed a building on property owned personally by one of its shareholders. In effect, the company has provided a benefit to its shareholder in the form of land improvements. Canada Revenue Agency could review this situation and increase the shareholder’s personal income for the total value of the winery building. The resulting tax and related interest charges on this amount would be significant.
Furthermore, in most situations, shareholders of winery corporations have lent their companies significant amounts of money. They may have even loaned money to the company to construct the building. Canada Revenue Agency does not have to recognize these shareholder loans to offset the net benefit that the shareholder has “received” in the form of land improvements. The tax authorities just look at the full value of the building as an improvement, regardless of how much money the company may owe the shareholder, and that is the taxable benefit. This approach doesn’t seem reasonable but quite often the Income Tax Act is not fair.
We had some winery owners come to us for assistance when they were in the middle of an audit for this very issue. Canada Revenue Agency was proposing to reassess the individuals for approximately $500,000, which was the value of the building their company had built on their land. The resulting tax bill would have rendered them insolvent and most likely bankrupt. Thankfully, we were able to argue that the individuals paid for the building with receipts in their own name, as opposed to utilizing corporate funds, and the reassessment was reversed. If these facts had not lined up in their favour, I suggest that Canada Revenue Agency would have been successful with their reassessment.
What can you do to guard against this issue? Make sure you understand the tax issues related to constructing a building on personally owned land. If a company constructs a building on personally owned land then the individual needs to report and pay tax on rental income received from the company. The rental income should be similar to fair market value rent that would be received in an arm’s length situation. It is vital that this arrangement is legally documented. Alternatively, it may make sense to have the individual construct the building and then lease it to the company. In this case, the shareholder owns the building, the company has not made an improvement to the individual’s land and a benefit to the shareholder does not exist. In addition, there may be GST issues to consider as well.
We regularly work with our clients to analyze the best approach for dealing with winery building construction. As demonstrated above, tax issues will impact the decision of who owns the building just as much as financing related issues. The important point to note is that you must work through the decision in a methodical manner with your professional advisors in order to avoid a serious tax problem. In this case, an ounce of proactive tax planning will prevent a pound of very expensive tax headaches later on.
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The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.