If a building meets the definition of being substantially renovated under subsection 123(1) of the Excise Tax Act, and is part of a residential complex, then it may be treated as a new house for GST/HST purposes. The sale of the building will then be subject to GST/HST under the same rules as a newly constructed residential complex. How do expert Toronto tax lawyers determine whether a substantial renovation has occurred?

This was the key issue in the Tax Court of Canada (“Tax Court”) of 2437299 Ontario Inc. vs. The King. The appellant, 2437299 Ontario Inc. (the “Company”), was engaged in building and renovating residential properties. In 2019, the CRA reassessed the Company for GST/HST collectible on the sale of two properties that the Company had renovated and sold during 2017. The Company contested the reassessments, asserting that it had not substantially renovated the properties. The Tax Court found in favor of the Company and agreed that the properties had not been substantially renovated.

Background – The Renovations

A significant portion of the Tax Court’s judgement was focused on the exact nature and extent of renovations that had occurred. The two properties that the Company had renovated were discussed separately as the Craven Road property and the Fourth Street property.

a) The Craven Road Property

The Craven Road property, before renovation by the Company, was a basic bungalow with an unfinished basement and a concrete foundation. The main floor consisted of a bedroom, kitchen, bathroom, combined living/dining room, and a small study. The kitchen had a significant portion of its interior perimeter wall made of plaster, which was replaced with drywall during renovation. The remaining walls in the kitchen and the entire interior were already constructed of drywall.

The renovation included constructing two additions: one extended the main level at the back of the house, and the other added an entire second floor with three bedrooms, an ensuite, and a regular bathroom. On the main floor, changes involved moving the kitchen, removing a bedroom, creating a family room in the back extension, and converting the former living/dining room into just a dining room. Interior stairs were added, extending from the basement to the two upper levels.

Windows on the side walls of the main level were closed off, a front window was enlarged, and a window was added to the back extension. The front door was replaced. While these changes were made on the main floor, the interior walls remained mostly unchanged, except for some fresh painting.

The main floor’s hardwood was covered with laminated wood, and the underlying hardwood was not removed. The sub-floor was unaltered. The main floor bathroom was changed to a powder room. In the unfinished basement, the interior perimeter walls were drywalled, and laminate wood flooring was installed over the concrete floor, except in the furnace area.

A new rear section of the basement became a storage space with access through a newly installed sliding door. The unfinished basement was further finished by adding a bathroom, laundry room, and flex space. Contrary to the Minister’s assumption that all walls in the house had been renovated, the court understood that the basement’s interior perimeter walls remained as brick and concrete.

b) Fourth Street property.

The Fourth Street property, before renovation by the Company, was originally a two-story house. The pre-renovation state included a basement with two rooms, potentially finished for use as an apartment, one of which might have been a study. There was a separate rear entrance and a mechanical room in the basement. The main floor comprised a living room, dining room, kitchen, bedroom, and bathroom. The second floor covered only the rear part of the building’s main level, featuring three small bedrooms with one washroom.

During the renovation, the Company relocated the mechanical room in the basement, added a bathroom, and included a room where the furnace area had been. The two rooms in the basement remained unchanged, with laminate flooring installed over the concrete floor. Stairs were moved from the back to one side.

On the main floor, an interior partition wall was removed to create a relatively large “open concept” area. The interior perimeter wall was retained, and changes included enlarging the front window, moving the front door slightly, adding a rear patio door and windows, and replacing carpet with laminate wood flooring.

Patching and painting of existing walls were carried out. In the second story, three small bedrooms and a bathroom existed initially. The sub-flooring of this upper story was extended to the front of the house during renovation. The second level received an addition of a large master bedroom with an ensuite, two smaller bedrooms each with an ensuite, and a laundry room. Large windows were installed in the newly extended front of the original second story of the building.

The Court’s Analysis – Were These Substantial Renovations?

This legal dispute hinged on the definition of “substantial renovation” as outlined in subsection 123(1) of the Excise Tax Act. The CRA assumed that the renovations met the criteria of “substantial renovation,” making the Company subject to GST/HST for the property sales. The Company argued that the renovations did not meet the legal definition of substantial renovation.

A “substantial renovation” is defined at subsection 123(1) of the Excise Tax Act as:

“substantial renovation” of a residential complex means the renovation or alteration of the whole, or that part of a building, […] to such an extent that all or substantially all of the building […] other than the foundation, external walls, interior supporting walls, floors, roof, staircases […] that existed immediately before the renovation or alteration was begun has been removed or replaced […]

The Tax Court referred to a 2005 information bulletin by the CRA to help guide its analysis of whether a substantial renovation had occurred. This was the GST/HST Technical Information Bulletin identified as B-092 and entitled “Substantial Renovations and the GST/HST New Housing Rebate.”  The Tax Court noted that this document is not legally binding but provides a detailed and lengthy explanation for three methods as being “typically” used to determine the extent of renovations. These methods are: (1) square footage of floor space of areas renovated compared to total floor space; (2) square footage of floor and wall space of the areas, renovated compared to the total floor and wall space of the building; and (3) number of rooms renovated compared to the total number of rooms in the building. In this case the parties had agreed to the second method, which the Tax Court followed.

The Tax Court also noted that bulletin B-092 states in part that “substantial renovations” means renovations to 90% or more of the building. This 90% figure has been judicially accepted in previous case law and the Tax Court agreed that it was reflective of the phrase “all or substantially all.” However, the Tax Court also found that it is undesirable to engage in complex arithmetic analysis as to whether the 90% threshold was met and noted that the figure does not appear in the “substantial renovation” statutory definition.

The Canadian tax litigation lawyer for the CRA argued that each property that the Company had been substantially renovated. Furthermore, the CRA argued that the sale of the two properties by the Company were then not exempted under the Excise Tax Act and that their sale constituted a taxable supply during the Company’s commercial activities. Thus, the sale of the properties was subject to GST/HST collectible. Additionally, the CRA argued that the Company was not entitled to the new housing rebate in respect of the sales. That in the absence in each case of an agreement between the Company and the property purchasers in the Company’s sale of the properties, the rebate belongs to the purchasers pursuant to subsections 254(2) and (4) of the Excise Tax Act.

When it came to arguing on the point of proving the substantial renovation the CRA argued that each property was above the 90% threshold. For the Craven Road property, the CRA argued that the total relevant area that was renovated was 100%. Whereas, for the Fourth Street property, the CRA argued that the total relevant area renovated was 90.6%. The Tax Court, however, found that due to the Company’s plans being not “sufficiently accurate and detailed,” such specific percentages of renovations were not readily calculatable.

The Tax Court instead of using precise percentages turned to the term “gutted” in case law. Whether or not the particular property in a case had been “gutted” was often used in previous case law in determining the nature of a renovation. The Tax Court found that the term implied that a property would have to have been gutted to have been 90% renovated. The Tax Court also noted that when it came to considering the floors of a building in renovations it was the sub-flooring that was to be considered in whether a building had been “gutted.”

The Tax Court found that neither property could be considered gutted or substantially renovated. In considering the Fourth Street property the Tax Court noted that the CRA had not recognized two rooms that were not changed by the renovation aside from laminate flooring being put down. Thus, that while this property was significantly renovated it was not substantially renovated. For the Craven Road property, the Tax Court found that based on the description of the renovation, as described above, that the building could not be considered “gutted.” Here again the Tax Court recognized that the building was “largely renovated,” but that it was not all or substantially all renovated. Thus, the Tax Court allowed the appeal, stating that the renovations undertaken by the Company did not constitute “substantial renovation” as defined by the Act. The case was then sent back to the CRA for reconsideration and reassessment.

Pro Tax Tips – Consult Before You Sell

The taxpayer in this case was successful in appealing the CRA’s determination, however whether a property has been, or will be, substantially renovated should be considered before a sale through consultation with an expert Canadian tax lawyer. This will allow for GST/HST to be properly considered in the agreement, and in the price, of the sale of the property. As the CRA tried arguing in this case, because the property was substantially renovated and GST/HST was not considered in the agreement, the Company was liable for paying the GST/HST collectible. Given the large monetary amounts in real estate transactions, this could have been a substantial tax bill if the Tax Court had not sided with the taxpayer. Canadian tax lawyers can assist in determining whether a property has undergone a substantial renovation and how to properly account for a substantial renovated property in a real estate transaction.

Frequently Asked Questions

Should I calculate the percentage of my renovations when determining if substantial renovation has taken place for GST/HST purposes?

Yes, if possible. The Tax Court in this case used the standard of whether the property was “gutted,” however having clear documentation showing a calculatable percentage below 90% would also help persuade the court. Of course, as seen in this case, percentages are not definitive, and a holistic consideration of the renovations should be done. A Canadian tax lawyer would be able to assist in assessing whether renovations would be considered to have gutted a property.

What are the implications of a property being treated as substantially renovated for GST/HST purposes?

If a property is considered substantially renovated and is part of a residential complex, it may be treated as a new house for GST/HST purposes. This means that the sale of the property would be subject to GST/HST under the same rules as a newly constructed residential complex. It is crucial to understand the extent of renovations and whether they meet the legal definition to determine the tax implications accurately.

DISCLAIMER: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the articles. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.