A Guide to Pre-Construction Assignment Transactions
The process of “assigning” an interest in an agreement of purchase and sale is a relatively new concept in Waterloo Region and it is quickly gaining traction. The problem is that the average purchaser does not understand the intricacies of what is involved in order to successfully assign an interest in an Agreement with minimal tax implications. A further problem is that the form of the Assignment Agreement is quite complex. The purpose of this article is to break down an assignment transaction into a scenario that is frequently encountered by real estate lawyers and agents.
In 2016, John (the “Assignor”) signs an Agreement of Purchase and Sale (the “Agreement”) to purchase a new condominium unit from Builder X (the “Builder”). He purchases this unit for $300,000.00 and, over the course of a year, he puts down a $45,000.00 deposit. The unit is scheduled to be completed in 2020. John predicts, that by the time the unit is built, it will be worth more than the $300,000.00 he originally paid. In 2019, John notices that the housing market in Waterloo Region is changing dramatically, that the Region has gained attention as a real estate hot spot and that John could stand to make a large profit if he sold his unit to a third party. Acting on these circumstances, John “assigns” his interest in the Agreement to Bob (the “Assignee”) for $380,000.00. In this process, Bob effectively steps into John’s shoes as the purchaser under the original Agreement with the Builder.
John needs assistance to ensure that he assigns his unit properly. John, being a prudent purchaser, asks his real estate lawyer to review the original Agreement between John and Builder X to confirm whether the Agreement contains specific language which prohibits or restricts John from assigning the Agreement to Bob, and whether John can assign the Agreement without obtaining prior written consent from Builder X. Spoiler alert: most pre-construction agreements contain this prohibition. In fact, most pre-construction agreements will contain wording to the effect that consent may be “unreasonably and arbitrarily withheld” by the builder or consent may be “at the builder’s sole and unfettered discretion”. In the event that written consent is provided, the builder will likely collect a fee for authorizing the assignment, prohibit any subsequent assignments and insist that the original buyer remain on the hook until final closing if the Assignee, Bob in this case, fails to complete the transaction with the Builder.
It is fortunate that John engaged his real estate lawyer prior to finalizing his transaction with Bob. John has discovered that Builder X will charge John a fee of $5,000.00 to authorize the assignment.
John’s lawyer has also flagged another concern: John’s initial deposit AND his profit may be taxable by the Canada Revenue Agency (“CRA”). Let’s explore why John’s lawyer believes the assignment transaction is taxable. Whether an assignment is taxable or exempt from HST turns on the status of the Assignor as a “builder” for HST purposes. If the Assignor (in this case, John) is considered to be a “builder”, the Assignor will be required to collect and remit HST on the markup earned through the assignment (in this case, $80,000.00). Exactly how does the CRA make this determination? The CRA looks at intention. In investigating the Assignor’s intention, it is necessary to look at the Assignor’s circumstances at the time the original Agreement was signed.
The CRA will look at several factors in determining John’s intentions. Here are a few:
- Is the Assignor a corporation?
- Does the Assignor take action to attract buyers while the property is under construction?
- How is the Assignor financing the purchase?
- Has the Assignor entered into multiple Agreements to purchase multiple units at around the same time?
- Is the Assignor’s stated intention to occupy the residence supported by his/her circumstances?
- Is the Assignor’s pattern of activity such that occupation of the property demonstrates that his/her use will not be permanent?
- Was the assignment triggered by an unforeseen and intervening event?
John’s lawyer determines that John’s primary purpose of purchasing the unit was to sell his interest in the unit to a third party. John lives and works in Toronto and is married with 4 children. The condominium unit he agreed to purchase from Builder X is in the heart of Uptown Waterloo – a stunning 600 Sq Ft studio. While John did not construct the unit, for GST/HST purposes, he is considered to be a builder as he was “intending to sell the property or an interest in it or to lease the property”. John doesn’t see how he can alter his circumstances to support an alternative intention. John is second guessing whether he should proceed with this assignment transaction as his profit margin is quickly declining.
Fortunately, John’s lawyer has a solution. John’s lawyer recommends to John that the assignment agreement should be worded such that HST is “in addition to” the assignment price as the transaction is subject to HST. John’s lawyer also adds a clause into Schedule “A” of the assignment agreement to confirm John’s intent to sell or lease the property. John is happy again.
Let’s revisit our scenario and think about what we’ve just discovered. The initial deposit is $45,000.00. John wants Bob to reimburse him for the deposit paid to Builder X. John also wants $80,000.00 (the “Assignment Fee”) from Bob in exchange for Bob taking John’s place as purchaser under the Agreement with Builder X. The total consideration is therefore $125,000.00 and all of it (yes, all of it – not just the profit but the deposit as well) is subject to taxation. Now Bob is unhappy.
Bob is concerned about HST. Bob engages his own lawyer. Bob’s lawyer reconfirms the HST implications in relation to the Assignment Fee and informs Bob that the Assignment Fee does not reflect his total financial obligation as the Assignee. Bob is a player in two distinct transactions:
- Transaction #1 = Bob’s Assignment from John
- Transaction #2 = Bob’s Purchase with Builder X
Bob’s lawyer reminds Bob that by entering into an Assignment Agreement, he is stepping into the shoes of John as the purchaser. Bob is assuming the original purchaser’s financial obligations under the Agreement with Builder X, however, Bob has no opportunity to renegotiate any of the terms of the original Agreement.
Bob’s lawyer wants to review the original Agreement, any amendments and notices to the Agreement and Builder X’s disclosure package. Bob’s lawyer brings the various closing adjustments to Bob’s attention. Bob will be on the hook for another $37,200.00 in adjustments to Builder X according to his lawyer’s estimations.
That’s not all. Bob’s responsibility to pay Land Transfer Tax (“LTT”) is also increased. In addition to paying LTT on the original purchase price of $300,000.00, Bob will also have to pay LTT on the Assignment Fee under the Assignment Agreement. Now Bob is very unhappy.
Bob’s lawyer has a recommendation for Bob. He suggests that Bob take advantage of the HST New Housing Rebate (“New Housing Rebate”). Bob already knows about this rebate. Bob is aware that under most new construction agreements it is assumed that the purchaser qualifies for the rebate and therefore the purchase price is listed as inclusive of the rebate for marketing purposes. In doing so, the builder fronts the rebate as a credit to the purchaser and applies to CRA following closing in order to recover the rebate from CRA. What Bob does not know is that if he submits a rebate application after completing his purchase with Builder X (as opposed to in conjunction with the transaction with Builder X), he will be able to claim the rebate over the Assignment Fee as well. If the Assignee meets the qualifications of the New Housing Rebate, the Assignee can recover from CRA a rebate for up to $24,000.00. Bob’s lawyer also tells him that only one New Housing Rebate application can be filed per dwelling.
To qualify for the New Housing Rebate, the applicant must: 1. Intend to acquire the property as a primary place of residence; 2. the property must never have been occupied prior to title transfer; and 3. the applicant (or their relative) must occupy the property continuously for a minimum of one year.
Bob’s lawyer concludes that Bob would benefit from applying for the New Housing Rebate on his own following the completion of the purchase transaction. Bob would be eligible for a rebate of $22,243.35 on the original Agreement price of $300,000.00. However on $380,000.00, the Assignment price, Bob’s rebate would increase to the maximum amount available: $24,000.00. Bob will recover an additional $1,756.65 if he applies for the rebate on his own. Bob is happy again!
As lawyers, it is important to ask our clients detailed questions prior to waiving a “lawyer review” condition in an agreement. Here is a list of questions a prudent lawyer would ask when presented with an assignment agreement:
- Has the Assignor provided the Assignee with the builder’s written consent to authorize the assignment agreement?
- Have the parties determined who will be responsible to pay any assignment fees if such are due to the builder?
- Is the Assignor’s deposit with the builder in good standing?
- If not, has the Assignor made arrangements to bring the deposit into good standing including any applicable NSF charges?
- Has the Assignor contracted with the builder for any upgrades to the property that have not yet been paid as of the date of entering into the Assignment Agreement?
- Is the Assignee permitted to contract for any additional upgrades with the builder?
- Does the Assignment Fee include the cost of the upgrades contracted for to date?
- Does the Assignment Fee include the cost of any “incentives” offered by the builder to the Assignor under the original Agreement? Are these incentives transferrable to the Assignee?
- Has the Assignee reviewed the disclosure statement and original Agreement? Has the Assignee noted the additional adjustments that may be payable to the builder upon final closing and is the Assignee aware that such adjustments are the Assignee’s responsibility?
- Has the Assignor provided the Assignee with all amendments, waivers and notices as provided by the Vendor?
- Has the Assignee ensured with its lender that the Assignee will qualify for financing to complete the transaction?
- Has proof of the Assignee’s financing been provided to the Assignor and to the Vendor?
- Does the Assignee qualify for the New Housing Rebate?
- Has the Assignee obtained confirmation from the builder that the Assignee will be credited with the New Housing Rebate on the builder’s statement of adjustments if the Assignee qualifies for rebate?
- Is it in the Assignee’s best interest to collect the New Housing Rebate through the purchase transaction?
- Have the parties agreed when the Assignment Fee will be paid by the Assignee to the Assignor? Will it be at completion of the purchase transaction or at the time the Assignment Agreement is accepted?
So, what happens to John, Bob and Builder X? After conferring with their respective lawyers and after serious negotiation, the parties agree as follows: Bob will purchase John’s interest in the unit for $380,000.00 + HST as further set out in Schedule “A” of the Assignment Agreement. John agrees to assume responsibility for HST on the deposit to be recovered ($45,000.00) from Bob. Bob agrees to remit HST on the $80,000.00 Assignment Fee. As Builder X has had little dealing with Bob to date, Builder X is happy to add the potential rebate amount ($22,243.35) back into the sale price of the unit ($300,000.00). Out of caution, Builder X’s consent to permit the assignment continues to hold John liable to complete the transaction in the event that Bob fails to do so. Bob completes both transactions and applies for the New Housing Rebate post-closing.