Contractual Joint Ventures for Real Estate: A Word Of Caution
Over the last few years, we have taken every occasion possible to preach caution to those wishing to use a contractual joint-venture to purchase an investment property, and with the plethora we have seen lately, we decided we’d take yet another opportunity to do so here.
Even as we continue to see contractual joint-venture agreements churned out one after the next, often bearing striking resemblance to each other despite the fees incurred by those presumably paying for a blackline document crafted specific to their own situations, we fully expect that it is not a matter of if but when a tax challenge is coming. That’s because, despite that it may state explicitly it is not a partnership, if the ultimate purpose is to share profits, and if the parties are in fact principals, then we believe that the relationship is that of a partnership.
To give you our reasoning, let’s proceed on the basis that there are three general vehicles by which a joint venture may take place; namely: A Joint-Venture Corporation (JVC), a Joint-Venture Partnership (JVP), and a Contractual Joint-Venture (CJV). Both statute and case law have dealt exhaustively with JVC’s and JVP’s, and the particular tax and other regulatory issues associated with each are well established.
And after writing that, I know what you’re thinking: since CJV’s don’t have all those tax and other regulatory concerns, isn’t that one of the best arguments in their favour?
Well it’s definitely one of the arguments given, but whenever it is I am quick to point out that the opposite is altogether true as well. Here is Barry J. Reiter and Melanie A. Shishler addressing the issue in Joint Ventures, Legal and Business Perspectives (Toronto: Irwin Law, 1999):
…the rights and obligations attaching to a CJV are less clear: partnership rules have been imposed on some contractual joint venturers and a complete lack of comparable protections has been the lot of others.
In other words, in the absence of specific rules, courts will either offer protection under other rules (usually those governing partnerships) or else no protection at all. This, to me, is enough of an argument not to use a CJV right there— that there is a chance that where the CJV agreement is silent, one of the joint-venturers can’t necessarily depend on the courts to enforce what would otherwise be enforceable if he or she were a member of a partnership.
Granted, CRA seems to accept joint-venture filings without dispute, which again is an argument given in their favour. The CRA publication on the issue is fairly detailed and is worth a read: http://www.cra-arc.gc.ca/E/pub/gl/p-171r/p-171r-e.html But being the former CRA auditor I am, I know that audit interpretations of bulletins and information circulars can vary widely, especially when nothing is codified and everything is fair game.
What’s more, with so many of the CJV’s we see having joint control issues, it’s not reassuring to know that CRA has never adopted a formal stance on the matter, continually pointing inquiries to the courts for guidance, although little can be found there. Robert Flannigan in “The Legal Status of the Joint Venture” (2009), makes the following commentary on the matter:
The difficulty with the joint venture aim is that while it is possible to pursue a joint objective and still avoid partnership regulation, it is not possible to do so where there is joint control. If the assets involved, whether contributed jointly or severally, are subject to joint direction in the production process, partnership status is engaged in order to impose the default regulation that reflects the social norms we apply to joint commercial effort.
Flannigan goes on to say that the concept of a joint venture has been dismissed by British and American courts, and the fact that it has been assigned a tax status in Canada does not make it any less likely to be dismissed by the courts here. In fact, as he puts it, things could get “messy really quickly” as courts will not be as convinced as many accountants are that there is truly a new legal status that exists between “partner” and “principal”.
In contrast, here is Justice Graham outlining the components of a joint-venture in a decision that has been referenced numerous times in the 40 years since, despite its obvious frailties:
(a) A contribution by the parties of money, property, effort, knowledge, skill or other asset to a common undertaking;
(b) A joint property interest in the subject matter of the venture;
(c) A right of mutual control or management of the enterprise;
(d) Expectation of profit, or the presence of “adventure”, as it is sometimes called;
(e) A right to participate in the profits;
(f) Most usually, limitation of the objective to a single undertaking or ad hoc enterprise.
In deciding whether or not to use a contractual joint-venture for your next real estate purchase, you will therefore rely either on Graham as cited above, or the likes of Flannigan, Reiter, and Shishler, who think there are much better options.
As for what the tax differences are between CJV’s and partnerships, we’ll save that for next time.
David Puotinen is the Tax Manager at Real File CPA in Markham, Ontario. He is a former criminal investigator, forensic auditor, and Small-and-medium-enterprise (SME) Audit training lead at the Canada Revenue Agency. Real File Chartered Professional Accountants is a boutique accounting firm with over 70 years of experience among its 3 senior accountants. It specializes in Canadian and cross-border tax planning for Real Estate businesses, developers, and investors.