Case Comment on Sura c. Agence du revenu du Québec, 2025 QCCQ 1127 ("Sura")
The Court of Quebec—which hears tax appeals under Quebec's income tax legislation—recently considered the tax consequences resulting from converting multi-unit rental properties into condominiums for sale. Quebec generally follows the Canada Revenue Agency ("CRA")'s published guidance on characterising gains from the disposition of real property, including in particular Income Tax Bulletin IT-218R,1 making the decision potentially of interest across Canada.
The Court essentially held that:
- contrary to what may be suggested at paragraph 13 of IT-218R ("Paragraph 13"), a conversion does not, in an of itself, represent a "change of use" of the property from capital property to inventory; and
- contrary to what appears in paragraph 15 of IT-218R ("Paragraph 15"), when a conversion results in a "change of use" from income-generating capital property to inventory, a deemed disposition takes place with the tax consequences to be applied in the year of conversion—as was held in 2013 by the Federal Court of Appeal in CAE2—not in the year when the properly is eventually sold.
The former holding is consistent with other recent decisions—including Latulippe3 from the Quebec Court of Appeal in 2019 and Polonovski from the Court of Quebec in 20204—that have rejected an audit practice from Revenu Québec ("RQ") to essentially deem any condo conversion as a "change of use" from capital property to inventory. While a welcome decision for taxpayers, it illustrates how the characterisation of property as "capital property" versus "inventory" is a matter of subjectivity and judgement with no clear-cut rules.
The latter holding, however, is of greater concern. Paragraph 15 sets out the CRA's position that when income-generating real property is converted to inventory for sale, there is no deemed disposition upon conversion. Rather, when the property is sold at a profit, the taxpayer must determine how much of the profit is attributable to the pre-conversion period (which is reported as a capital gain) and how much is attributable to the post-conversion period (which is reported as business income). The approach is generally favourable to taxpayers, since it does not entail any tax liability until a sale has taken place and (presumably) the proceeds from that sale actually received.
When the Federal Court of Appeal held, in CAE, that there was no legal basis for the methodology in Paragraph 15, and that a change of use from income-generating capital property to inventory entails a deemed disposition in the year of the change,5 the CRA announced—to the general approval of the tax community—that it considered that holding incorrect obiter dicta and would not follow it.6 RQ soon followed suit.7 And indeed, in Polonovski, the Court of Quebec agreed with RQ and upheld an assessment based on Paragraph 15.
While Sura's holding with respect to Paragraph 15 is obiter dicta and thus, in principle, not precedential, its strong endorsement of CAE may be difficult for RQ (or even the CRA) to ignore. Given that it is not clear when or if the Federal Court of Appeal may have the opportunity to reconsider Paragraph 15, clarification from the legislature would be very welcome.
The Facts
Sura involved ten individual taxpayers (or their estates) who, back in the 1980's, collectively acquired two adjoining rental apartment buildings on the West Island of Montreal with a total of 82 units.8 Between 1981 and 2005, the ten taxpayers held the properties as investments and declared all rental income appropriately.9 Two of the taxpayers (the husband and wife John and Mary Sura) managed the properties, while the other eight taxpayers were passive investors.10 By 2005, the taxpayers were reaching the age of retirement and decided to dispose of the properties, and they determined that they could obtain the best return by converting the properties into condominiums.11 The conversion was initiated in 2005 and completed in 2006.12 The various tenancies continued however, and the taxpayers continued earning rental income following the conversion.13
Between 2006 and 2009, however, the taxpayers sold 52 condo units, reporting the gains on sale—without controversy—as capital gains.14 Between 2010 and 2013, the taxpayers sold a further 12 units.15 With respect to those taxation years, RQ took the position that the conversion in 2006 constituted a "change in use" of the properties, such that they ceased to be capital property and instead became "inventory" of a property business. Accordingly, RQ disallowed all depreciation taken in respect of the units, reclassified the taxpayers' rental income as business income, and reassessed the gains arising upon sale of each unit using the methodology set out in Paragraph 15, namely that, in the year of sale of a unit:16
- the increase in value of a unit between 1981 and 2006 was included as a capital gain; and
- the increase in value of a unit between 2006 and the sale was included as business income.
As mentioned above, in 2013, the Federal Court of Appeal held that there was no statutory basis for Paragraph 15, and that rather under the Income Tax Act (Canada),17 a "change of use" from capital property to inventory can only trigger a deemed disposition in the year of the change. The CRA, however, summarily rejected CAE and has declined to amend IT-218R, announcing at the 2013 Canadian Tax Foundation Annual Conference Roundtable that:18
With respect, we do not agree with the comments of the FCA regarding the change in use rules. In particular, we are of the view that the FCA's interpretation leads to an untenable result, since it requires the same words to be interpreted differently for business property and personal use property—this problem is acknowledged by the FCA itself. Moreover, it is not clear to us that the FCA's interpretation on this point is consistent with the object, spirit and context of the provisions in question. Finally, it appears to us that it would be challenging for both taxpayers and the CRA to apply the change in use rules in the manner outlined by the FCA. Reporting requirements and potential tax liability for every change from inventory to (income-earning) capital use, and vice versa, could represent a significant compliance and administrative burden.
The CRA acknowledges that the considered comments of the FCA must be taken into account in interpreting the Act. However, for all of the reasons mentioned previously, and as, on this issue, the comments of the FCA in C.A.E. are obiter dicta, the CRA will not be changing its general position on the change in use rules as currently presented in Interpretation Bulletins IT-102R2 and IT-218R.
The Issues
The taxpayers denied that any "change of use" had occurred with respect to the properties, such that the condos remained capital property at all times.
They also argued, in the alternative, that if a "change of use" had occurred, then in accordance with CAE, a deemed capital gain in respect of the condo units would have arisen and been taxable in 2006 (which, by that point, had become statute-barred), not in the year of the sale of the particular condo units.19
The Decision
Justice Bourgeois, on behalf of the Court of Quebec, noted that the Quebec courts tend to follow the CRA's interpretation bulletins on characterising gains from the disposition of real property.20 Accordingly, he reviewed the criteria set out in IT-218R to distinguish capital property from inventory, with emphasis on the taxpayer's intention at the time of acquisition.21 He also took note of Paragraph 13, which states that:
The units in a multi-unit residential apartment, or an office, warehouse storage building or any similar structure that is held as capital property by the owner will be considered to have been converted to inventory at the time when application is made to the relevant authority for approval to change the title to any such building to strata title, provided that the owner proceeds with the sale of the units.
Applying these principles, Justice Bourgeois held that the taxpayers' intentions vis-à-vis the two properties had not changed throughout their decades of ownership. They acquired the properties as rental properties and used them at all times as rental properties, including after the 2006 conversion. Citing the 1984 Tax Court of Canada's decision in A P Cantor,22 as well as the 2019 Quebec Court of Appeal decision in Latulippe, the Court held that a conversion of a multi-unit rental property into single units, effected simply to maximise the return from an anticipated sale, did not transform the units from capital property to inventory, notwithstanding the language that may appear in Paragraph 13.23 The Court distinguished the more recent Court of Quebec decision in Gagliano,24 which concerned a conversion of a multi-unit property accompanied by a major renovation that entailed considerable financial risk for the owners, such that the Court held that the conversion effected a change of use from capital property to inventory.25
This holding with respect to the change of use rendered moot the issue of IT-218 Paragraph 15. However, as obiter dicta, Justice Bourgeois expressed strong disapproval of RQ's refusal to follow CAE,26 which Justice Bourgeois considered "logical and pertinent" and "developed over 18 paragraphs".27
Observations
As was documented in Polonovski—a decision that was apparently not brought to Justice Bourgeois' attention—RQ apparently pursued a major audit project about 10 years ago involving condo conversions, in which it relied on Paragraph 13 to essentially "deem" any condo conversion—regardless of the attendant circumstances—as precipitating a conversion from capital property to inventory.28 This theory was rejected in both Polonovski and Latulippe.29
While a welcome result for taxpayers, the Court's holding underscores the lack of any bright-line rules to determine whether a "change of use" occurs in the context of a condo conversion. Indeed, the Court may well have come to a different result if, for example, the taxpayers had undertaken substantial renovations of the properties prior to sale (as occurred in Gagliano). Property owners contemplating a conversion of multi-user rental property into condominiums or other stand-alone units will want to consider carefully whether they wish to maintain the property's status as capital property following the conversion and, if so, what steps they should take (or not take) to do so.
Of potentially greater concern is the Court's holding with respect to Paragraph 15, which calls into question the validity of the CRA's and RQ's longstanding position that CAE's holdings with respect to Paragraph 15 were incorrect and should not be followed. Polonovski came to the opposite conclusion, noting that:30
To retain the argument suggested by the plaintiffs would result in the taxation of a capital gain at the moment of conversion, while the property has not yet been sold and the proceeds of sale not yet received. It is the disposition of the property that has a tax consequence and for this reason, it is placed at the moment of the actual disposition. [...]
One can understand here that the argument is interesting for the plaintiffs, which allows them to claim that the capital gain should have been taxed in 2010 and to be able to claim that the year is statute-barred. However, in all other cases, especially when the building is sold years later, the taxpayer would be heavily disadvantaged in the scenario proposed by the plaintiffs.
As noted in Polonovski, the approach endorsed in CAE with respect of a conversion of income-generating capital property to inventory held for sale would oblige taxpayers to self-declare and remit tax upon the conversion—which would generally take place before any cash receipts, and thus discourage property development projects that may depend on the conversion. The approach set out in Paragraph 15, whereby any gains attributable to the pre-conversion period are only taxed in the year of sale, is more favourable to taxpayers and more consistent with the economic and commercial reality.
It is unfortunate that Polonovski was apparently not brought to Justice Bourgeois' attention, since taxpayers are now left with two conflicting decisions on Paragraph 15, thus potentially re-opening a debate that was previously believed settled.
Unfortunately, if RQ (and even the CRA) conclude that CAE reflects the actual state of the law as will be enforced by the Courts, they may start insisting taxpayers self-assess tax on nominal capital gains that are deemed to be realised upon the conversion of property, which would be an unwelcome development. Until and unless the appellate courts can weigh in, a legislative intervention to clarify matters would no doubt be welcome.
Footnotes
1. Canada Revenue Agency, IT-218R: Profit, Capital Gains and Losses from the Sale of Real Estate, Including Farmland and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and Vice Versa (September 16, 1986) [archived] ("IT-218R").
2. CAE Inc v Canada, 2013 FCA 92 ("CAE").
3. Latulippe c. Agence du revenu du Québec, 2019 QCCA 2177 ("Latulippe").
4. Polonovski c. Agence du revenu du Québec, 2020 QCCQ 8943 ("Polonovski").
5. CAE, supra note 3 ¶85 et seq.
6. CRA Document 2013-0493811C6 ("Change in Use") (November 26, 2013) [Taxnet Pro] ("CRA Document 2013-0493811C6").
7. Revenu Québec Document 15-024384-001 ("Conversion ou non d'un immeuble") (September 21, 2015).
8. Sura ¶4-5.
9. Sura ¶7.
10. Sura ¶8.
11. Sura ¶9-11.
12. Sura ¶12-13.
13. Sura ¶13.
14. Sura ¶15.
15. Sura ¶16-17.
16. Sura ¶18-23.
17. RSC 1985, c. 1 (5th Supp).
18. CRA Document 2013-0493811C6, supra note 6.
19. Sura ¶27-28. As a secondary issue, Revenu Quebec also reassessed John and Mary Sura for amounts received as fees for managing the properties between 2010 and 2013. During these taxation years, however, the Suras lived in the United States, and they claimed that the fees were exempt from taxation in Quebec pursuant to the Canada-US Tax Treaty. Revenu Quebec ultimately conceded this point in their closing argument (Sura ¶150).
20. Sura ¶39-40.
21. Sura ¶41-44.
22. A P Cantor v MNR, [1985] 1 CTC 2059 (TCC).
23. Sura ¶65-67, 88.
24. Gagliano c. Agence du revenu du Québec, 2023 QCCQ 7958.
25. Sura ¶93-106. The Court also noted that the taxpayers in Gagliano were considerably more experienced as property managers.
26. Justice Bourgeois also noted that if a change in use had taken place, it would have been in 2005 rather than 2006 (Sura ¶108-109).
27. Sura ¶123 [translation by author].
28. Polonovski, supra note 4 ¶11-12.
29. Setting aside the fact that CRA interpretation bulletins do not have force of law, Paragraph 13—read in context—is primarily concerned with determining the timing of a change of use in the context of condo conversion—not whether a change of use has taken place.
30. Polonovski, supra note 4 ¶208-210 [translation by author].
The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.
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