There are lots of great ways to pursue your goals with respect to real estate related investing. And as pointed out in a recent blog, a Joint Venture is a great option to consider. We looked at a short grocery list of important and foundational concepts in our previous discussions and simply highlighted some issues. We looked briefly at what a Joint Venture is and what it’s not. And highlighted some basic accounting, legal and bank financing issues too.
Here are a couple more things to understand and consider . . . .
Sorry. I know how much we all enjoy taxes. And how much we thoroughly enjoy administrating, collecting and remitting taxes on behalf of the government under the federal and provincial goods and services tax regime. Most of us are both tax collectors and payers. But we continue our joint venture discussion here just to get the worst out of the way. You may recall the legal distinctions made previously where I made some important points about what we call things. Corporations, individuals, partnerships and joint ventures are different. They are treated differently on several levels, and GST/HST is one area where the distinctions in legal status are important. A Joint Venture is not a “person” for GST/HST purposes. Accordingly, each venturer would be required to report and remit GST/HST if it were not for Section 273 of the Excise Tax Act. It allows a little bit of legal fiction. A Joint Venture will be treated ‘like’ a partnership for GST/HST purposes, so that one entity (called an “operator”) can be appointed to file and report GST/HST on behalf of the Joint Venture provided the operator is a “participant” in the Joint Venture.
But as with all things GST/HST, it can’t just be simple with the folks at CRA. A “participant” is defined as a person who, under a written joint venture agreement actually makes an investment by contributing resources (and shares in revenue or losses of the venture) or a person without a financial interest, but is designated as the operator in the agreement who is responsible for the managerial or operational control of the Joint Venture. So a couple of things flow from this. First, this issue must be addressed in a written Joint Venture agreement. No verbal agreements – and no written agreements that are silent on the matter will suffice. Second, you cannot simply incorporate or appoint a legal entity as the operator (GST/HST administrator) who is just a bare trustee.
So what’s the big deal? A bare trustee is usually a person who holds legal title to the lands and (a) has no other responsibilities, independent powers, or discretion, or (b) it’s primary function is to hold title for the benefit of the other participants in the venture or (c) it just carries out limited functions at the direction of the venturers. If you set up your Joint Venture where the designated operator is simply a bare trustee, CRA may not in fact allow it to qualify as the operator. The danger is that CRA could then assess GST/HST, interest and penalties against each venturer since they in effect would have been deemed to have failed to collect and remit GST/HST to the extent of their separate and individual ownership interest. Moral of the story? Get your Joint Venture Agreements reviewed this year and then make sure your accountant is reporting and filing GST/HST properly with respect to the Joint Venture!
Ok, now that we got that nasty bit of news out of the way, on to more pleasant business . . . . divorce. Yes, sometimes the friends and buddies we enter into business with just turn out to be brutes and knaves. Or circumstances come to pass that make staying together less than optimum. Often you can negotiate a tidy and mutually agreeable exit and all is well. But just as often, brutes and circumstances make it impossible to mutually agree about anything. So your agreement needs an exit strategy. This is one area where well known corporate concepts can overlap. Your Joint Venture agreement should have at least two exit strategies just like most Unanimous Shareholder Agreements.
"Yes, sometimes the friends and buddies we enter into business with just turn out to be brutes and knaves. Or circumstances come to pass that make staying together less than optimum."
Option to Purchase:
First, you should have a clause allowing the other venturers to purchase the interest of another venturer upon certain triggering events (such as death, bankruptcy, etc). This is logical where the parties don’t necessarily want to be in business together with anyone other than the exiting venturer (and certainly not a trustee in bankruptcy or venturer’s sixth cousin twice removed).
Second, you should have another clause, often called a buy/sell or ‘shot-gun’ clause, which allows a party to present an offer to purchase another party’s interest. The person receiving such an offer must either accept it (and thus sell) or shoot it back, forcing the initiating party to sell. As you no doubt noticed, the initiating party takes a risk since he must be ready to both sell and buy. A nice result of that, though, is that the offer has to be at fair price. This is a ‘final straw’ remedy to get out from a bad situation. It’s always better and easier and more pleasant to just agree – and in real estate, liquidating the underlying joint venture assets and dissolving the entire joint venture arrangement is oftentimes an easier divorce procedure than either of these.
So there you have it: a couple more grocery items for your Joint Venture shopping cart. As you can see, the written agreement is essential. It cannot be ignored or considered inconsequential.
Originally published in the REIN Real Estate Report