Tax Alert – Commercial landlords offering rent deferrals may face tax consequences

April 14, 2020

Commercial landlords are generally required to account for GST/HST and QST at the time rent is payable under a lease agreement including any additional rent such as property taxes, even if a landlord has not received a payment from the tenant. In the current environment with widespread business closures and interruptions due to the COVID-19 pandemic, many landlords and tenants are entering into informal arrangements for a temporary reduction or deferral of commercial rent. A landlord that agrees to provide a temporary rent reduction or to defer a lease payment to a later time may face unintended GST/HST and QST consequences.

Tax is payable based on written agreement

The tenant may also be entitled to recover any GST/HST and QST payable as an input tax credit or refund, even if the rent was not paid. A tenant that is in a credit position may receive a refund from Canada Revenue Agency and Revenue Quebec because of input tax credits and refunds arising from GST/HST and QST that was never paid to the landlord. Although a deferral of GST/HST and QST payments until June 30, 2020 is available to landlords, economists suggest that cash flow issues may persist well beyond the deferral date and landlords may be required to remit tax they never received from tenants.

GST/HST and QST on commercial rentals is generally payable based on the day each lease payment becomes due under a written agreement. GST/HST and QST collectible must be reported by the landlord in the tax reporting period which the payment becomes due according to the lease agreement, even though it may not be received until a subsequent reporting period.

In a worst-case scenario where the funds are never recovered from the tenant, the landlord may eventually be entitled to recover the GST/HST and QST component of a bad debt. This will generally require that the landlord be able to demonstrate that all reasonable steps were taken to recover the rent payments and it is evident that the debt in not collectible. In the meantime, the landlord would be out-of-pocket after remitting tax that was never collected from the tenant.

Formal rent deferral agreements

To protect themselves from additional risk, landlords should consider formalizing any rent deferral or reduction arrangements with tenants by entering into written agreements that amend or override payment terms of the original lease agreement. If the terms of the new agreement govern tax collection and reporting obligations, landlords may avoid additional undue risk in relation to GST/HST and QST that was collectible under the terms of the original agreement.

BDO Law's Valeriya Lee advised that, in addition to the GST/HST and QST concerns, it is incumbent upon landlords to ensure they have skillfully drafted lease deferral agreements in place to prevent frustration of a lease. In addition, this is to prevent a tenant from simply taking the risk of stopping their payment of rent in hope that the landlord simply cannot re-let the premises. It also shows good faith and investment by the landlord in the success and financial health of its tenants. Not opening the conversation of deferral with commercial tenants can result in tenants vacating the premises without notice or payment of penalty and the necessity of landlords filing expensive lawsuits to collect outstanding rent.

Application of security deposit against amount owing

Another potential solution may be for the landlord to agree to apply a security deposit toward a lease payment as a temporary relief measure. A deposit is not subject to GST/HST or QST until it is applied as consideration towards the rent by the landlord. The application of the deposit towards a rental payment may require the landlord to report GST/HST and QST that was never collected from the tenant. The landlord should ensure to collect the applicable taxes from the tenant if it applies a security deposit against a lease payment.

It is in the best interest of landlords and tenants to work together and bargain in good faith to weather this crisis while avoiding unintended tax consequences.

Landlords considering rent deferral arrangements should take appropriate steps to prevent having to remit tax that could remain uncollected from tenants and should ensure any deferral arrangement is protected by a deferral agreement drafted by a lawyer.

We can help. Contact BDO Canada's Indirect Tax team to discuss your situation. BDO Law is also available to assist in drafting formal deferral agreements.

Shelley Smith, Partner, Indirect Tax Practice Leader

Brian Morcombe, Partner, Indirect Tax

Dave Walsh, Partner, Tax Service Line Leader

The information in this publication is current as of April 08, 2020.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

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