In a move which many Canadians, especially those who have been persistently priced out of the housing market, welcomed with open arms, overnight Finance Minister Bill Morneau unveiled new measures aimed at slowing the flood of foreign money pouring into overheated housing markets like Vancouver and Toronto, a move which some dubbed an unprecedented federal intervention in the sector.
As first reported by the Globe and Mail, Ottawa announced it would close a tax loophole that allows non-residents to buy homes and later claim a tax exemption on the sales.
According to the revision, the government will make sure the principal-residence exemption is only available to individuals who reside in Canada in the year the home is purchased, which immediately excludes thousands of "hot money" Chinese tourists who come to Canada simply to park billions in Chinese cash.
The Ottawa shift comes after home prices soared dramatically the last few years in the Vancouver and Toronto markets, triggering a vigorous debate about the role of foreign money. As reported in the summer, British Columbia imposed a 15-per-cent foreign buyers tax on homes which led to a dramatic cooling in the Vancouver housing market. Just today we learned that Vancouver home sales had plunged another 32.6% relative to a year ago as the market remains paralyzed as a result of a lack of buyers willing to chase near record prices.
The finance minister also announced new measures to combat offshore speculation, including closing the loophole. The moves follow a Globe and Mail investigation that revealed a network of speculators flipping homes for profit and avoiding taxes by classifying them as principal residences. Under the Canadian tax code, homeowners do not have to report the sale of any property that they designate their principal residence, and do not pay tax on the increased value – or capital gains – of that home. In order to make that designation, a homeowner, their current or former spouse or any of their children must have lived in it at some time during the year for which the designation is claimed.
However, there has been widespread abuse of the exemption by foreign buyers who claim residency either for themselves or their spouses or children simply in order to avoid paying taxes on real estate speculation. Non-resident investors must pay capital gains tax at the time of a sale.
Multiple sources have told The Globe of the widespread abuse of the primary-residency exemptions in the Greater Vancouver area. The Globe has seen hundreds of cases in which homemakers or students were listed as registered owners on multimillion-dollar residential properties.
The new measure would make the exemptions available only to home buyers who are residents at the time of purchase.
Not surprisingly, and as Zero Hedge readers have known since early 2016 when we first started profiling the Canadian housing bubble, a previous B&M investigation discovered such cases usually involve a wealthy breadwinner who earns their living in another country, while parking money in Canada, through buying residential properties. Some of the homes are used by family members; others are simply left vacant.
Several expert sources told The Globe there are two ways to exploit the system – to sell those properties and pay no taxes. In the first scenario, the breadwinner claims to be a non-resident of Canada and pays no taxes here, while their spouse and children buy and sell homes registered in their names. The homes are purchased with money received as a “gift” from the breadwinner. The homes can then be sold tax-free, because the family members claim to be residents of Canada, classify the properties as their principal residences, and therefore pay no tax when they sell.
A second scenario revealed more widespread abuse, namely one in which the breadwinner claims to be a resident of Canada but then doesn’t report their worldwide income to the Canada Revenue Agency, as required by law. Because they claim to be residents, they can sell Canadian properties in their name, tax-free, even if they spend little or no time in Canada. If these homeowners make their living in China, experts said it’s difficult for anyone to determine what they actually earn, because it’s next to impossible to get tax records from that country, even though China and Canada have a long-standing tax treaty. As a result, experts say, these wealthy people get away with claiming little or no income on their Canadian tax returns, while selling homes tax-free.
In order to halt this abuse, G&M reports that experts urged Ottawa to require taxpayers to report the sale of all homes, even if they are claiming the principal-residence exemption. “Everybody’s biggest lifetime gain is from principal residence and [Canada Revenue Agency] is saying if you are a resident it is tax free and if you are a resident we don’t worry,” one Vancouver real estate accountant said Sunday. He spoke on the condition he not be identified out of fear of repercussions.
“So the CRA pushes them into residency claims. A wife and kid are allowed to stay in Canada as a resident and as such they are entitled to tax-free principal residence and as such they don’t have to report it.”
While it is unclear what the effect will be on the Canadian housing market as a result of this first intervention by the government into the housing market, but the market is already responding. The stocks of some of Canada's largest mortgage-lending companies fell after the announced changes which as a result of tightened mortgage eligibility and the closed tax loophole would mean less business for lenders.
Laggards led by Genworth MI Canada, Equitable Group; Mortgage-finance companies sliding intraday were MIC CN down as much as 12%, EQB CN -10%, FN CN -7.7%, and HCG CN -3.8%.
On TSX, Bloomberg notes that the real estate sector was also falling, mostly led by residential and diversified REITs.
Sellsider opined: RBC analyst Geoffrey Kwan said policy change is negative as new premiums written in S-T likely to be weak on slow home- sales activity, adding that it was a "net negative for high loan-to-value (LTV) new premiums written as this will results in significant number of borrowers to be unable to qualify." He also said that the changes was a “slight” net negative for low LTV insurance new premium written as it would likely reduce demand but “slightly” offset by higher prices. Elsewhere, Keefe, Bruyette analyst Brian Klock said new mortgage measures may dampen Canadian mortgage, housing growth; but the ultimate impact would be difficult to judge right now. He also said the possibility of lenders sharing more risk; may result in changes in the way banks underwrite and price mortgages, reserve for losses, manage capital.
Finally, RBC senior economist Robert Hogue said policy change would affect first-time homebuyers most and will have an effect across Canada, not just in Vancouver, Toronto.
Which for a country where housing has for the past few years seemed dramatically unaffordable to most local residents, may not be such a bad thing.