There are nearly 40,000 real estate agents in Toronto; that is one agent for every 140 Torontonians! In Vancouver, the numbers are even more staggering - one agent for every 61 Vancouverites. It helps, of course, that the market is sizzling hot, but across Canada, the competition among realtors is fierce. In order to stand out from their competitors and attract potential buyers, some agents offer so-called commission rebates (a.k.a. “kickbacks”).
This is how it works: an agent tells potential buyers that if they hire her, she will redirect a portion (ex. 20%) of her commission to be paid to the buyers. If the buyers purchase a house for $1 million, the agent receives $25,000 + HST commission from the vendors, and then pays 20%, or $5,000, to her clients. To sweeten the deal even further, some agents advise clients that the rebates are always non-taxable.
Here is the problem. Such advice is only correct if your buyers purchase the property for personal use. If they purchase an investment or a “flip” property, there are tax consequences.
Rebate is not Taxable for Personal Use Buyers
Under the Income Tax Act (Canada), only “income from a source” such as business, property or employment, is taxable. Windfalls, gifts or lottery winnings are generally not taxable because they don’t originate from “a source” as specified in the Act.
As you’re buying your family home or a cottage, you’re not engaged in earning income from business or property. Therefore, the rebate you receive is not what we tax lawyers call “income from a source.” Just like that gift basket you received from your agent on closing, it’s not taxable.
Uncertainty for Investment Buyers: Taxable Income vs. Decreased Cost
Until July of 2020, the CRA’s official position appeared to be that the rebate would decrease the cost of the investment/rental property, which could increase capital gain. Using the example above, the buyer’s cost would be $995,000 ($1 million minus $5,000 rebate). If she later sells the property for $1.2 million, she will pay tax on a capital gain of $205,000 and not $200,000.
In July of 2020, however, the Tax Court of Canada’s decision in Zhang v. The Queen, 2020 TCC 49 was released. Zhang purchased four condominiums in Toronto with the intention of renting them out through a corporation, which was created later. Zhang’s agent paid $27,236 to her in commission rebates. The agent’s brokerage issued a T4A slip to Zhang but she did not report it in her tax return. The CRA included $27,236 in her taxable income. Zhang appealed.
The Court held that the rebate was “income from a source” and was taxable in the year the taxpayer received it. The result is unfortunate to the taxpayer and was even less favourable than the CRA’s own published position, whereby the rebate would only decrease her cost base in the properties.
Zhang chose not to hire a lawyer and represented herself in Court. Some wonder whether it explains the unfavourable result. Others wonder whether the existence of a rental corporation played a role in the Court’s reasoning.
In short, after July of 2020, we do not know if the CRA plans to use Zhang as a precedent-setting authority to make rebates on investment purchases taxable in the year they are received. But stay tuned.
For Business Buyers the Rebate is Taxable in the Year Received
If the buyer is in the business of buying and selling (or flipping) real estate, the rebate is taxable income from the business, regardless whether a T4A was issued or not. Professional real estate buyers should also discuss HST applications of rebates with their tax advisors.
What to Do with T4As?
Some brokerages issue T4A slips to all buyers who received commission rebates, no matter what “type” of buyer they are. If you received such T4A, consult with your tax advisor. If your advisor confirms that the rebate is not taxable to you, contact the brokerage who issued the T4A and ask them to cancel it. If you purchased a “flip” property, your advisor will include the T4A in your tax return for the year. But if you purchased an investment, your advisor should determine whether or not Zhang applies to you.
Rebates are Deductible to Agents
What about agents? The rebates are deductible from the income of the agent provided the payment was reasonable and had true business purpose. But if the agent and the buyer are related, the CRA will be watching. Converting taxable commission income of an agent into a non-taxable rebate to a close family member will not work.
Originally published in The Lawyer's Daily (by LexisNexis Canada) on July 6, 2021 https://www.thelawyersdaily.ca/articles/28085/real-estate-agents-beware-commission-rebates-can-be-taxable-to-clients
Please note that this post is only as current as its publishing date indicates, but the relevant rules change constantly.