Dispositions by Non-Residents of Canadian Real Property — Taxation & Compliance Requirements

This article was originally published in Blakes Bulletin on Cross-Border Tax, March 2006

A non-resident is liable to tax in Canada on income from a variety of domestic sources. Included among these is income from a business carried on in Canada and taxable capital gains from the disposition of "taxable Canadian properties" other than "treaty-protected properties". Taxable Canadian property includes, among other assets, real or immovable property situated in Canada, property used or held by the taxpayer in a business carried on in Canada and a share of the capital stock of a corporation resident in Canada that is not listed on a prescribed stock exchange. Also included in the definition is a share of the capital stock of a non-resident corporation (not listed on a prescribed stock exchange) if at any time during the preceding five-year period the fair market value of the taxable Canadian property owned by it is greater than 50% of the fair market value of all of its properties and more than 50% of the fair market value of the share is derived directly or indirectly from a combination of assets including real or immovable property situated in Canada.

The OECD Model Convention contemplates that gains derived by a resident of a contracting state from the alienation of immovable property situated in the other contracting state may be taxed in the latter jurisdiction. Similarly, gains derived by a resident of a contracting state from the alienation of shares deriving more than 50% of their value directly or indirectly from immovable property situated in the other contracting state may also be taxed in the latter state. Gains from the alienation of any property other than that specifically referred to is taxable only in the state of which the taxpayer is a resident.

Canada has entered into a broad network of bilateral tax conventions that generally follow the OECD Model Convention and that may protect a non-resident from Canadian tax on capital gains that would otherwise be taxable under domestic legislation. The most obvious situation in which treaty protection would be available is a disposition by a resident of a treaty jurisdiction of shares of a Canadian corporation that do not derive more than 50% of their value directly or indirectly from immovable property situated in Canada. Some, but not all, of the tax treaties to which Canada is a signatory go further than the OECD Model Convention and define immovable property for purposes of treaty protection so as not to include, in determining whether the shares of a corporation derive more than 50% of their value from real property situated in Canada, real property (other than rental property) in which the business of the company is carried on. For example, this extended exemption is to be found in Canada’s tax convention with the United Kingdom but, as of yet, is not included in the convention with the United States.

In order to ensure collection of tax owing, a non-resident who disposes of most types of taxable Canadian property (the prime exception being shares listed on a prescribed stock exchange) is required to apply for and obtain a tax clearance certificate. This requirement to complete the tax clearance process is imposed whether or not there is a gain from the disposition and whether or not a treaty exemption applies.

The necessary documentation must be filed by the vendor with the Canada Revenue Agency (CRA) prior to or within 10 days immediately following the disposition and must set out details of the transaction including the identification of the parties, a description of the property, the anticipated proceeds of sale, a computation of the resultant gain or loss and a statement as to whether the transaction is at arm’s length or between related parties. The CRA will, after processing the notice, determine the amount of tax, if any, that is payable and negotiate appropriate arrangements for payment of tax or the posting of security. It will then issue a certificate indicating the disclosed proceeds of sale (in the case of a notice filed prior to disposition) or a statement that all tax owing has been paid (in the case of a notice filed post closing).

To enforce this requirement, the purchaser is obligated to obtain from the vendor a copy of the certificate issued by CRA confirming that the appropriate notification procedure has been completed and setting forth the maximum price that may be paid by the purchaser without any withholding requirement (or, where the notification has been filed after the date of disposition, confirming that no amount need be withheld from the purchase price).

The purchaser is authorized and required to withhold from the consideration paid to the vendor an amount equal to 25% (or 50% in the case of depreciable and certain other property) of the amount by which the purchase price exceeds the limit set out in the CRA certificate. If no certificate has been provided at closing, the purchaser is required to withhold 25% (or 50% as applicable) of the purchase price. Any amount that has been so withheld must be remitted to CRA by the 30th day of the month following the month in which the closing occurs.

If the purchaser disregards these requirements and fails to withhold as set out above, the purchaser is itself liable to pay an amount equal to what it ought to have withheld. Any amount withheld by the purchaser, or paid by it as a consequence of its failure to require production of the appropriate clearance certificate, is credited to the vendor on account of any tax for which it may be liable. The vendor may, upon filing a tax return, claim a refund of any excess of the amount paid on account over its actual tax liability. The purchaser is entitled to recover from the vendor any amount it has been required to pay as a consequence of failure to comply with the procedures described above, but enforcement of this right may be a difficult matter.

Where no certificate is available at closing, or where the certificate indicates a purchase price less than the amount actually payable by the purchaser, the necessary deduction from the proceeds of sale will typically be held in escrow until the date on which it must be remitted to CRA. This raises the issues of identifying the appropriate escrow agent and negotiating the terms of an escrow agreement describing the circumstances in which the funds may be dispersed and to whom.

In the event an amount has been withheld and no certificate is available by the date on which the funds must otherwise be remitted to CRA, it may be possible to obtain a "comfort letter" from CRA confirming that remittance may be delayed without penalties until the tax clearance procedure has been completed. While there does not appear to be a legislative basis for relying on such a comfort letter, it is common practice to do so.

Where there has been a disposition of taxable Canadian property, the vendor is required to file a return of income for the year in which the disposition occurs and report the results of the transaction whether or not tax is payable.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.