Canada: Incorporation Of Real Estate Agents: Canadian Tax Lawyer Perspective

Recent Updates to the Law Allow Incorporation for Real Estate Agents

On October 1, 2020, Ontario Regulation 536/200 updated the Real Estate and Business Brokers Act to allow real estate agents to incorporate. Real estate agents who wish to incorporate are limited to forming a particular type of corporation called a "Personal Real Estate Corporation" (PREC). Creating and operating this type of corporation involves certain requirements not imposed on other corporations. These requirements will be discussed in further detail below, along with the tax and legal benefits of forming a PREC.

The Trust in Real Estate Services Act received royal assent in March of 2020. Once this Act comes into force, the Real Estate and Business Brokers Act will be retitled the Trust in Real Estate Services Act.

Unique Regulations Applicable to Personal Real Estate Corporation

Corporations formed in Canada or a particular province must comply with the relevant requirements of the law under which they are incorporating. For corporations related to a particular profession, such as medical corporations and professional corporations for lawyers, must also abide by the requirements of the particular law or regulation which allows those professionals to incorporate. The same applies to PRECs.

The following are the requirements applicable to PRECs:

• Must be incorporated under the Business Corporations Act. This is Ontario's Corporations Act. PRECs must act in compliance with the incorporation requirements under that Act.
• The controlling shareholder must be a broker or salesperson registered with the Real Estate Council of Ontario (RECO). A PREC is not required to independently register with RECO as long as the controlling shareholder is an existing RECO registrant.
• The controlling shareholder of the PREC must also be the PREC's sole director and officer.
• There must be no agreement or arrangement that limits the controlling shareholder and sole director's ability to manage or supervise the PREC.
• The controlling shareholder must directly or indirectly legally and beneficially own all equity shares in the PREC. These equity shares are the only shares of the PREC with voting rights.
• Non-voting or non-equity shares of the PREC can be owned legally and/or beneficially either directly or indirectly by the controlling shareholder or his or her parents, spouse or children.
• The PREC cannot trade real estate, except where employed by a broker.

Tax Benefits of Incorporating a Personal Real Estate Corporation

The new ability for real estate agents to incorporate PRECs makes available the numerous tax benefits of operating a business through a corporation. These include lower tax rates, deferrals, income splitting and tax planning opportunities.

Corporations are taxed at a lower tax rate on active business income than individual taxpayers, and depending on their income, can take advantage of the small business deduction. A corporation can retain the money it earns for furthering the business or investment purposes for as long as it is in operation. This defers adding the income of the PREC to the reported income of the real estate agent for as long as is advantageous and appropriate. However Canadian controlled private corporations (CCPCs) that earn passive investment income in excess of $50,000 will not be able to claim the full small business deduction. The exact decrease to the small business deduction depends on the amount of passive investment income earned by the CCPC. Once the money is removed from the corporation, such as by way of a dividend or salary, the taxpayer receiving the funds will pay tax on the funds at his or her tax rate. Corporate tax rules, specifically the dividend tax credit, prevent this resulting in double taxation of both the corporation and recipient of the funds and ensure the overall rate of taxation is the same as if the money had been earned directly by the individual.

Income splitting (or income sprinkling) is where income from one taxpayer is attributed to the family member of that taxpayer. Taxpayers participate in income splitting to take advantage of the lower tax rate of certain family members while still making the income available to the family. Since the PREC regulations allow family members of the real estate agent to own shares in the PREC, this creates income splitting opportunities. Recently, the Tax on Income Splitting (TOSI) rules were expanded to further limit allowable income splitting. These rules are beyond the scope of this article, but they are complex. Those who wish to engage in income splitting are advised to first speak to one of our Canadian tax lawyers.

The Lifetime Capital Gains Exemption or LCGE allows a taxpayer to sell the shares of a qualifying small business corporation without incurring tax up to the exemption limit which was $866,912 in 2019 and is increasing on an annual basis. This means shareholders of the PREC are able to sell their shares in the PREC tax-free if the lifetime capital gains exemption qualifying conditions are met. However, the new shareholders of the PREC must comply with the regulations described above or the corporation will no longer be able to operate as a PREC.

Deferrals and income splitting create tax planning opportunities for real estate agents who incorporate a PREC. For example, the average taxpayer will enter a lower tax bracket upon retirement. If the taxpayer is a real estate agent with a PREC, he or she could defer withdrawal of the funds from the PREC until he or she enters this lower tax bracket. This deferral results in lower tax on income for the real estate agent.

A PREC additionally provides benefits for retirement planning, as well as medical and dental benefits. An Individual Pension Plan ("IPP") can provide significantly higher contribution rates than a Registered Retirement Savings Plan ("RRSP") and they permit registrants to make an additional one-time lump-sum contribution. This means that if registrants are unable to contribute to their IPP immediately, they can carry forward their contribution room and make a one-time large lump-sum contribution in the future when their earnings increase. A Health and Welfare Trust ("HAWT") (also referred to as a Health and Welfare Plan) is a tax planning arrangement which allows professional corporations to provide their employees with reimbursements for medical and dental expenses. As a tax planning benefit, HAWTs allow deductibility of the contributions made to the plan for the professional corporation.

Incorporating a PREC impacts contributions to the Canadian Pension Plan (CPP) as well. As self-employed individuals, real estate agents remit both the employer and employee portion of the CPP. A real estate agent who operates a PREC could cause the corporation to issue him or herself a dividend instead of a salary. This would remove the requirement to remit the CPP payments on the real estate agent's renumeration. Choosing a dividend instead of salary though may impact the real estate agent's ability to engage in other retirement planning such as making RRSP contributions.

Tax and Cost Negatives of Incorporating a Personal Real Estate Corporation

Once a real estate agent incorporates a PREC that corporation is a legally separate person from the real estate agent. This can create certain benefits, but depending on the real estate agent and PREC's particular circumstances, it may also create disadvantages which make incorporation of a PREC less desirable.

The main downside of incorporating a PREC is the additional administrative costs. As a separate person, the PREC will need to maintain its own accounting and records, have its own GST/HST registration, file its own taxes and make all necessary corporate filings. These administrative costs may outweigh the benefits enumerated above but generally do not.

Incorporating a PREC may additionally prevent the real estate agent from using a powerful tax tool - losses. When a taxpayer incurs a loss, that taxpayer can use the loss to decrease the amount of tax owing. If the taxpayer cannot utilize the entirety of that loss in the tax year it is earned, the taxpayer can carry that loss forwarded or backwards to decrease the tax owing in surrounding tax years. How many years a loss can be carried over depends on the nature of the loss. These different types of losses can also only be used to decrease related types of income. Once incorporated though, any losses incurred by the PREC belong solely to the PREC. The real estate agent cannot employ the PREC's losses to decrease his or her personal taxes. Although losses will be available to reduce past or future corporate earnings.

Even though the PREC is a legally separate person, real estate agents should be aware they can still be held liable for the actions of the PREC under the Excise Tax Act and Income Tax Act. In particular, director's liability provisions allow the Canada Revenue Agency to pursue the director of a corporation for the unremitted payroll taxes and GST/HST of the corporation. Since the real estate agent must be the PREC's sole director, that person can be held liable for the PREC's non-compliance with its payroll tax and GST/HST obligations. Similarly, operating as a PREC does not shield the real estate agent from potential personal liability for his or her provision of real estate services. A real estate agent cannot utilize a PREC to avoid his or her professional liability.

Pro Tax Tips: Identifying Whether a PREC is Advantageous

Though PRECs are now available for real estate agents, real estate agents should not rush to file for incorporation. Creating a corporation without understanding the particular rules applicable to corporations or whether it is advantageous to incorporate in your particular circumstances could cause you to miss out on tax savings or incur unnecessary costs. Real estate agents considering incorporating a PREC should speak to one of our experienced Canadian tax lawyers to fully understand the benefits of the PREC and whether a PREC would be beneficial in his or her circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.