By George E. Dube, CPA, CA
In any joint venture, talking about what really matters and then having a clear written record, is a key part of the process. What happens then when you have to think about how the Canada Revenue Agency (CRA) interprets your words and writing in dealing with joint venture relationships?
Let’s talk about five key points on joint ventures and tax that really matter to you, to your co-venturers, and to the CRA.
1. Do not let this term pass your lips…
If you’ve heard me speak, you’ve heard me say, “Stop using the term ‘joint venture partner’.” Please, just stop. Now.
It seems like the natural term to use right? From a purely business/relationship standpoint, the term “partners” seem reflective of the nature of what you are trying to accomplish in a joint venture deal. But, from a tax perspective, this term can allow the CRA to create havoc for you. If you are referring to JV partners in emails, contracts, discussions, and so on, the CRA can argue that you are investing as a partner as compared to more common investment vehicles.
So what, you ask? Let’s look at some practical implications.
The key differences from a tax perspective between a joint venture and a partnership involve:
- how income and expenses are brought into an investor’s income
- what amounts must be reported similarly between investors (with depreciation or capital cost allowance often being the largest difference between JV’s and partnerships)
- what forms must be used for tax reporting
- when the forms are due
As you can see, these are not small differences.
2. The right words can close deals
At breakfast this morning I had the privilege of helping a friend start to put together a real estate deal. The terminology was critical in dealing with the parties involved. One investor appeared to be frightened of being a “partner” with the others potentially involved in the deal for legal and relationship reasons. By being able to fluently discuss a joint venture as distinct from a partnership, my friend will be able to alleviate these concerns and help close the deal. Discussing these differences, along with utilizing the guidance of a real estate lawyer, is opening up several new alternatives to the group which allows for win-win relationships.
3. Clear terminology = clear deals = closed deals
If you are the “real estate expert” who is cultivating a new co-venturer for your deal but are in fact using the incorrect terminology, this can lead to confusion. Confusion can lead to a “no”, “not yet”, and ultimately “no deal”. This is particularly true when dealing with knowledgeable investors looking at your joint venture agreements with their experienced team of real estate accountants, and lawyers.
A little patience and understanding of the basic terminology and rules that apply to the investment opportunities that you are presenting to the investors can alleviate most issues. For example, knowing exactly what tax reporting is required, what forms are needed, what investors pay taxes on, and when the reporting to the government is due is crucial, but frequently misunderstood. Recently, in one case we dealt with, the lawyer, accountant, real estate expert and investor had four different understandings of these details because they didn’t receive the right information. Needless to say this created confusion and reduced confidence in the real estate expert.
4. The right paperwork can save deals and money
Getting the proper joint venture paperwork in place will save you money in the long run and ensures your reputation.
We are currently in the process of fixing the tax returns for a number of investors where the “real estate expert” put together a templated JV contract. “Fortunately” they saved a few hundred dollars in professional fees by not having a draft contract reviewed. Unfortunately, they have incorrectly filed their prior tax returns, face an assortment of penalties, and are left holding the bag while we get to correct all of this. The “real estate expert” doesn’t look as experienced now in his investor’s eyes.
With the advice of your lawyer and real estate accountant, tailor your JV templates to your unique situation and that of your investors. Yes, you can use them as a master template provided the templates are reviewed periodically for any needed technical updates or changes to your investment strategy, for example. This takes a little time and money, but from our experience is far cheaper than the alternative.
5. The right paperwork = properly filed tax returns and financial statements
Ensure your joint venture agreements are reviewed from a tax and accounting perspective so that the annual financial and tax reporting are correctly done and deadlines are met. Keep in mind that different business relationships have very different reporting needs. This may seem odd, but a number of our clients look to “save” money by simply providing a quick summary of the nature of the agreements. This is technically all that is required when we prepare certain financial statements and tax returns which then allows us to complete the annual financial work. Often though, our clients misunderstand or are not aware of a key element, which then comes out a few years down the road because the CRA or an investor has identified a potential issue.
Further, we highly recommend allowing the advisors to speak with each other, including your mortgage plan advisor, to ensure that all are on the same page, or if not, allow them the chance to identify the differences and recommend a go-forward strategy.
Joint venture terminology and agreements have critical implications. Take the time to ensure that you and your team are aware of the differences between joint ventures and other investment relationships such as partnerships. Know what is specifically relevant to you and your investors. A brief review with your team of advisors can make your investment life much easier, help you create and maintain your “real estate expert” status in the eyes of your investors, and keep the CRA from knocking on your door.
George is a veteran real estate investor and accountant (CPA). He has spoken, written various articles, and co-authored two books on real estate accounting. Reach George at: firstname.lastname@example.org or @georgeEdube.