Commencing from the beginning of 2009 new Canadian tax rules came into effect in respect of the sale of property by non-residents. Whenever a non-resident is involved in a transaction, withholding tax requirements can arise. The new rules affect the liability of the parties for tax and, as a result, new and special provisions may be required in the transaction documents to address these rules.
What you need to know
Non-resident vendors as well as purchasers can both be liable for Canadian income tax on the disposition of certain types of Canadian-based property such as Canadian real estate and shares of Canadian companies. Clearance certificates can be obtained from the Canada Revenue Agency ("CRA") to protect purchasers from liability, but the new rules involve special procedures, raise legal issues, and may require additional contractual protection for purchasers. Therefore, anyone acting in a transaction involving the disposition of Canadian-based property by a non-resident of Canada should consult a tax professional for advice on the rules, and for assistance in drafting suitable provisions to include in the transaction documents. This is the case whether you are acting for the vendor OR for the purchaser. It is important to get tax input early in the process, before your client begins to commit to positions in the deal.
Please note that although these new procedures were advertised as simplifying the requirements under section 116 of the Income Tax Act (Canada) ("Act"), and many people believe that to be the case, in most situations it simply is not true.
We often provide legal advice in transactions involving the acquisition, disposition or reorganization of Canadian-based property held by non-residents of Canada. Any time a non-resident disposes of Canadian-based property, the potential application of the withholding tax rules in section 116 of the Act should be considered. These rules apply to taxable Canadian property, life insurance policies in Canada, Canadian resource property, timber resource property, and interests in or options in respect of any such property.
The 2008 Federal Budget proposed amendments to the clearance certificate and withholding tax rules in section 116 of the Act, as described in an earlier bulletin. The amendments have now been enacted with effect as of January 1, 2009.
The intent of the amendments was to simplify the administrative burden of section 116, and avoid the long processing delays when a non-resident disposes of property, where the gain is not ultimately taxable in Canada because of protection available to a vendor under a tax treaty. However, the new rules have not resulted in this being the case.
In theory, under the new rules a purchaser will no longer have to withhold from the gross purchase price on the purchase of treaty-protected property. However, in practice a number of difficulties are raised. To rely on the new procedures, the purchaser must determine that the non-resident vendor is a resident of a country with which Canada has a tax treaty. The purchaser must also be satisfied the property is treaty-protected. If the purchaser is satisfied, then withholding can be eliminated if the purchaser sends a special notification to the CRA within 30 days of the acquisition.
In reality, an element of risk remains with the purchaser under the new rules. For example, although a due diligence defence is available in determining the residence of the vendor, CRA has not provided guidelines on what level of due diligence is required by the purchaser to meet the "reasonable enquiry" test. Even more problematic, there is no due diligence defence for purchasers in determining whether the property is treaty-protected. A number of detailed factual and legal questions are raised in determining whether the vendor is entitled to treaty benefits. If the property is not treaty-protected, the purchaser will remain liable for the withholding tax.
If there is any uncertainty as to the residence of the vendor, or the status of the property, it may be advisable to insist that the non-resident vendor provide the purchaser with a clearance certificate issued by the CRA, and for the purchaser to withhold tax from the gross purchase price until a clearance certificate is received. Even if the purchaser is satisfied that the property is treaty-protected, and wishes to make use of the new rules, the purchaser should obtain suitable representations and warranties, together with indemnification or security, from the vendor.
One point of clarification should be made for real estate lawyers in respect of the information set out above. The changes included in section 116 of the Act relate to what is known as "treaty protected property". Unfortunately, this type of property does not include real property (i.e. land, bricks and mortar).
Accordingly, whenever dealing with a non-resident in a real estate deal, the new simplified section 116 procedures will not be available.
Because of the complexity of the new rules, we invite you to contact a member of the Tax NPG whenever you encounter a transaction involving a non-resident. The tax rules may have significant tax implications to both parties and should be considered in every case.
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.