Skip Ribbon Commands
Skip to main content

The Capital Erosion Conundrum


​​​​​​​​​Tax represents one of the most significant costs incurred by any real estate or construction firm in Canada. In recent years, these tax costs have also become one of the greatest constraints on firms’ investible capital, inadvertently keeping product off the market as companies strive to reduce their tax burden. To do so, some companies adopt highly aggressive strategies to minimize their taxes, which can land them in a dispute with the Canada Revenue Agency (CRA) or other tax authorities. Reasonable expectations and realistic, early tax planning can help companies avoid the risk of running afoul of the CRA while reducing capital erosion.

Soaring Prices, Tax Costs Impacting Market

The CRA is sometimes referred to as a company’s largest “silent business partner,” receiving its share of business income without fail each year and contributing nothing in return. It’s an unavoidable fact of doing business and one that many business owners resent, at least to some degree. In the real estate and construction sector, however, this resentment over tax costs is having unintended consequences.

Over the past several decades, Canadian real estate values have risen at a phenomenal rate, powered ever higher by both market dynamics and ordinary inflation. Properties built to market value in the 1970s or 1980s are now worth many multiples more today. Yet real estate companies are reluctant to part with older, now more valuable properties because of the tax implications. The high tax cost of a sale could actually leave them with less capital available for subsequent investment.

Tax-driven capital erosion has, as a result, become a significant inhibitor of capital movement in the Canadian real estate and construction sector. Investors large and small bemoan the lack of quality product available on the market and one of the reasons for this is that owners are so reluctant to sell and incur a sizeable tax bill.

​This article is part of a series on key tax issues facing Canada’s real estate and construction companies.

​ ​ Read other articles in the series.​ ​​

Companies Risk Overaggressive Strategies

Not surprisingly, real estate companies are eager to find ways to minimize the tax costs of an asset sale to retain more of the proceeds and preserve their investible capital. However, many firms rely on their ordinary, day-to-day business advisors to do so. These advisors frequently lack the highly specialized expertise needed to ensure the transaction is structured in such a way that it will stand up to tax authorities’ scrutiny.

And there will be scrutiny. The CRA and its counterparts around the world have grown increasingly aggressive in recent years as they work to maximize tax revenues and prevent tax leakage. On a host of issues, not just asset sales, companies find themselves required to mount strenuous and often costly defences of their tax planning strategies. And they don’t always win.

This is especially worrisome for companies that take extremely aggressive tax positions to limit or even attempt to eliminate the tax burden on an asset sale. Companies considering such options need to not only take into account the cost of setting up such techniques, but the legal costs of defending it down the road.

Five Steps to Success

Proper planning around the sale or disposal of a property or other asset is essential to avoid eroding the investible capital available to a real estate or construction company. It is also important to realize highly aggressive strategies can lead to sizeable legal costs and penalties if tax authorities fail to accept them.

The following steps can help you effectively manage and minimize the tax cost of an asset sale and prevent capital erosion:

  • Start early. Companies can often minimize their tax burden — or fund future tax obligations — through the use of proper tax structures. But it can take years to properly design and implement those structures. Start now to achieve optimum results. If you wait, it may prove too late to achieve your tax objectives.
  • Plan with the sale in mind. When it comes to asset acquisitions and sales, we encourage companies to “plan for the exit.” When purchasing a property, make sure you and your advisors take the time to ensure the right tax structure is in place to minimize the tax bill on its eventual sale.
  • Have reasonable expectations. Paying zero tax on an asset sale is wishful thinking; paying the minimum tax, on the other hand, is an achievable goal. Having reasonable expectations will keep you and your advisors focused on feasible, well-founded solutions.
  • Understand the full picture on tax. Is your company prepared for the tax consequences of a sharp rise in valuations? What if the tax authorities disagree with your position on the tax treatment of a transaction? Understanding the tax risks your company faces can help you take mitigating steps and make better decisions.
  • Capitalize on external advisors’ expertise. In today’s world of aggressive tax authorities, tackling complex tax issues on your own is a risky move. Specialized external advisors can provide the experience and expertise your company needs to implement forward-thinking tax planning that stands up to scrutiny.

​Tax issues don’t have to hinder your ability to act

Taxes may be inevitable, but capital erosion doesn’t have to be. By planning for the likely tax costs of an asset sale early, real estate and construction companies can help minimize their tax obligations while preserving their capital for future investment. And that can unlock opportunities not just for them, but the industry as a whole.

For more information, contact:

Eddy Burrello, CPA, CA
T: 647.943.4081
E: [email protected]

Glenn Willis, CPA, CA, CPA, CMA
T: 416.515.3850
E: [email protected]

This is the third in a series of MNP perspectives on key tax issues facing Canada’s real estate and construction companies. Other pieces have explored important tax considerations at play in business succession planning, doing business across borders, valuations and business consolidation. Click here to read the next article in the series.

Click here to download this article.