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The Quebec Court of Appeal recently ruled, twice rather than once, on the distinction between capital gain and business income when selling real estate. In the Bishara[1] and Latulippe[2] cases, the Court of Appeal overturned the trial decisions of the Court of Québec, thereby ruling in favour of the taxpayers involved.

In Bishara, the position of the Court of Québec, like that of the Quebec Revenue Agency, was essentially based on the available documentary evidence. Since the taxpayer had made sales of immovables with similar conditions in a short period of time and the holding period of the immovables was brief, the Quebec Revenue Agency considered that the primary and/or secondary intention of the taxpayer at the time of the purchase was to make a profit on the resale. The Court of Quebec, for its part, considered that the taxpayer had not presented sufficient evidence to reverse the presumption of validity of the assessment issued, considering furthermore that the factual framework according to the available documentary evidence supported the position of the Quebec Revenue Agency.

The Court of Appeal, analyzing the evidence, considered that the holding of each of the buildings for periods of six months and fourteen months respectively before the sale offering of each one could be sufficient to demonstrate an intention to live in these buildings, while the Court of Quebec had stated that the buildings had been held for "a few weeks". Also, although the transactions were similar and close in time, the taxpayer's explanation to justify the moves, and therefore the purchases and sales of the buildings, was deemed consistent by the Court of Appeal, since the Court of Quebec failed to explain in its decision why the taxpayer's version was questioned and why he should be attributed an intention to make a profit rather than an intention to remain in the buildings.

The Court of Appeal therefore overturned the Court of Quebec's decision and cancelled the assessment issued by the Agency, thus recognizing that the income was not business income, but capital gain, 50% of which is not taxable.

As for the Latulippe decision, rendered on December 16, 2019, it also reiterates the criteria relating to the primary and secondary intention of a taxpayer when purchasing a building, which are determining factors in qualifying the income resulting from the sale of said building. The Court of Appeal pointed out that the fact of considering, at the time of purchase, that a sale could be made at a profit if a sufficiently high offer is received is not sufficient for there to be an adventure in the nature of trade, which would be an additional indication that a business has been undertaken.

This decision is also relevant in the context of the conversion of buildings into condominiums. Indeed, paragraph 13 of Federal Interpretation Bulletin IT-218R " Profits, 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” provides that when real property held as capital property is converted to divided condos, it is deemed to be converted to inventory. In practical terms, since the sale of property held as inventory creates business income rather than a capital gain, income from the sale of real property converted to condominiums would be considered business income.

Based on this interpretation, the Quebec Revenue Agency considered in Latulippe that a conversion into a divided or undivided co-ownership necessarily resulted in business income. The Court of Appeal indicated that not only must the analysis be made despite the interpretation of IT-218R and that it cannot automatically create business income, but also that there was no business income in the situation presented.

In fact, the buildings had been held for several years by the taxpayers, who eventually decided to convert them into condominiums in order to maximize the resale value. However, unlike the Quebec Revenue Agency, the Court of Appeal considered that there was no business risk in proceeding in this way, business risk being another of the criteria for business income, since the conversion was made in a market favourable to resale. Moreover, to the extent that the intention to convert for resale at a profit was not present at the time of the acquisition, the conversion just before the property was put up for sale did not change the taxpayers' original intention.

The Court of Appeal therefore concluded in this decision that there could be a capital gain on the sale despite a conversion to co-ownership during the previous months.

Do not hesitate to contact the members of our team if you have a real estate project or if you have received a notice of assessment recharacterizing the income from the sale of a property.

[1] Bishara c. Agence du revenu du Québec, 2020 QCCA 854

[2] Latulippe c. Agence du revenu du Québec, 2019 QCCA 2177