Incorporation Of Real Estate Agents: Canadian Tax Lawyer Perspective – Tax – Canada – Mondaq News Alerts

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.

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