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The 2010 Budget tabled by the Canadian federal government has proposed significant changes to the rules applicable to non-residents that dispose of certain taxable Canadian property. Section 116 of the Income Tax Act imposes rules regarding clearance certificates ("Section 116 Certificates") required to be issued upon the disposition of "taxable Canadian property" by a non-resident. By re-defining "taxable Canadian property" in a way that reduces what is included under this definition, the proposed amendments will fundamentally alter the reach of the Section 116 process.
Background on Section 116
Section 116 of the Income Tax Act stipulates that non-resident vendors who dispose of taxable Canadian property must obtain a Section 116 Certificate from Canada Revenue Agency ("CRA"). A Section 116 Certificate provides evidence of the amount of withholding tax payable on the disposition of taxable Canadian property by a non-resident vendor. The process for obtaining such a certificate is lengthy and complex and is further described below. Budget 2010 has proposed to reduce the number of items that qualify as "taxable Canadian property", thereby eliminating the Section 116 filing requirements for a significant number of transactions.
New definition of "Taxable Canadian Property"
The new definition of "taxable Canadian property", found in section 248(1), includes the following and is applicable for dispositions occurring after March 5, 2010:
a.real property situated in Canada,
b.property used or held by the taxpayer in, eligible capital property in respect of, or property described in an inventory of, a business carried on in Canada, other than
ii.where the taxpayer is non-resident, ships and aircraft used principally in international traffic and personal property pertaining to their operation if the country in which the taxpayer is resident does not impose tax on gains of persons resident in Canada from dispositions of such property,
c.if the taxpayer is an insurer, its designated insurance property for the year,
d.a share of the capital stock of a corporation (other than a mutual fund corporation) that is not listed on a designated stock exchange, an interest in a partnership or an interest in a trust (other than a unit of a mutual fund trust or an income interest in a trust resident in Canada), if, at any particular time during the 60-month period that ends at that time, more than 50% of the fair market value of the share or interest, as the case may be, was derived indirectly from one or any combination of
ii.Canadian resource properties;
iii.timber resource properties, and
iv.options in respect of, or interests in, or for civil law rights in, property described in any of subparagraphs (i) to (iii), whether or not the property exists,
e.a share of the capital stock of a corporation that is listed on a designated stock exchange, a share of the capital stock of a mutual fund corporation or a unit of a mutual fund trust, if, at any particular time during the 60-month period that ends at that time,
B.persons with whom the taxpayer did not deal at arm's length, and
f.an option in respect of, or an interest in, or for civil law a right in, a property described in any of paragraphs (a) to (e), whether or not the property exists,
Effect of the New Definition of "Taxable Canadian Property"
The changes announced in Budget 2010 eliminate the application of section 116 withholding tax and clearance certificate requirements for shares in private Canadian corporations and certain other interests ) – unless the value of the shares is derived principally (more than 50%) from real property, resource property or timber resource property in Canada (or was so derived at any time within the previous 60 months). These rules will also apply for an interest in a partnership or an interest in a trust (but not a mutual fund trust or an income interest in a Canadian trust). This change is significant as it creates a much more welcoming atmosphere for potential foreign investors in Canadian companies by removing from many transactions the hurdles of the Section 116 regime.
Foreign investors that resided in a treaty jurisdiction and invested in private Canadian corporations are generally protected from Canadian tax on capital gains but were previously required to obtain a Section 116 certificate. As noted below, the Section 116 rules require that tax be withheld by a purchaser on the sale of taxable Canadian property pending receipt of a clearance certificate. This compliance burden was often cited by foreign investors as a sufficient reason to dismiss Canadian investment opportunities.
Tax relief is also provided for investors from non-treaty jurisdictions. The exclusion of certain private Canadian corporations from the definition of "taxable Canadian property" means that capital gains on such investments are no longer taxable in Canada to any foreign investor.
The Process for Obtaining a Section 116 Certificate for Dispositions of Taxable Canadian Property
The mechanics of the process for obtaining a Section 116 certificate are set out in Section 116 itself and remain in place for those items that would still qualify as "taxable Canadian property" under the amended definition.
Where a non-resident person proposes to dispose of taxable Canadian property (other than "excluded property", which includes shares or a corporation listed on a recognized stock exchange, a unit of a mutual fund trust, a bond, debenture, mortgage or similar obligation, and "treaty-exempt property"), the non-resident may, before the disposition, send a notice to the Minister indicating:
- the name and address of the proposed purchaser;
- a description of the property sufficient to identify it;
- the estimated amount of the proceeds of disposition; and
- the amount of the adjusted cost base ("ACB") of the property to the non-resident vendor at the time of the sending of the notice.
If the gain is not taxable, the notice should be accompanied with supporting documentation. If the gain is taxable, the notice should be accompanied with either 25% of the amount by which the estimated proceeds exceed the adjusted cost base of the property to the non-resident, or acceptable security. The Minister must then issue to the non-resident vendor and the proposed purchaser a Section 116 Certificate on which an amount is fixed (the "Certificate Limit") equal to the estimated proceeds set out in the notice.
A purchaser must pay tax on 25% of the amount by which the cost of the property to the purchaser exceeds the Certificate Limit, and therefore should ensure that the Purchase Agreement permits the purchaser to withhold this amount pending receipt of the Section 116 Certificate.
Where a non-resident person disposes of taxable Canadian property and has not already obtained a Section 116 Certificate, the non-resident person must, within 10 days of the date of disposition, send a notice to the Minister stating:
- the name and address of the proposed purchaser;
- a description of the property sufficient to identify it;
- the amount of actual proceeds of disposition; and
- the ACB to the non-resident of the property immediately before the disposition.
The non-resident vendor who has already disposed of the property is not required to file this notice provided:
- it has already filed a notice (the "Original Notice") regarding the same disposition prior to the disposition,
- the purchaser listed on the Original Notice is the purchaser,
- the estimated proceeds in the Original Notice are equal to or greater than the actual proceeds, and
- the amount indicated as the ACB of the property on the Original Notice does not exceed the ACB to the non-resident vendor immediately before the disposition.
Any notice sent by the vendor following a disposition should be accompanied by the payment of applicable tax, or if no tax is payable, supporting documentation. Once the Minister has received this material, the Minister will issue to the non-resident vendor and to the purchaser a Section 116 Certificate indicating the actual proceeds of disposition as set out in the Notice. This Certificate serves as a full release of liability for the purchaser.
If no certificate is delivered to the purchaser, the purchaser is liable to remit, on behalf of the non-resident vendor, an amount equal to 25% of the cost to the purchaser of the property. The purchaser must remit this amount within 30 days after the end of the month in which the purchaser acquired the property.
In such a scenario, the purchaser should seek a letter of comfort from CRA by notifying them of the transaction and holding 25% of the proceeds in escrow. The comfort letter confirms that the purchaser may continue to retain the withheld funds beyond the remittance date. This allows any funds in excess of tax payable to be released directly to the vendor upon issuance of a Section 116 Certificate.
Obtaining a letter of comfort is favourable for a vendor. If the purchaser remits the entire amount withheld, the vendor must wait until CRA has assessed its Canadian tax return for that year in order to receive a refund of any excess amount remitted.
An Onerous and Bothersome Process
As can be seen from the above description of the Section 116 process required for dispositions of items that are taxable Canadian property, the process is onerous. Foreign investors have no doubt been dissuaded in the past from investing in Canada due to the administrative burden that they would later face under the Section 116 regime when they sell the property. In the past, the requirements to file notices together with the fact that 25% of the vendor's sale proceeds may be inaccessible for months until a Section 116 Certificate is issued were enough to make foreign investors look elsewhere for opportunities.
By decreasing the number of items encompassed by the definition of "taxable Canadian property", the federal government is attempting to remove a roadblock hindering foreign investment.
A Final Note of Caution
If the 2010 Budget proposals become law, purchasers should still exercise caution. In many circumstances, a purchaser will have sufficient knowledge and information about the target corporation, partnership or trust and its operations and assets during the prior 60 months to determine whether the property it is purchasing is "taxable Canadian property". However, the purchaser is at risk if there is uncertainty or if it is subsequently determined that the purchased property was "taxable Canadian property". For example, there may have been a point in time during the 60 months prior to a sale when more than 50% of the value of the property was derived from real property in Canada. Therefore, in certain circumstances it may be prudent for purchasers who acquire property from non-residents to obtain protection, by way of indemnities or otherwise, with respect to the target's asset mix during the preceding 60 months.
Regardless of the easing of the section 116 restrictions by Budget 2010, advice from tax professionals should be sought for any dispositions involving non-resident vendors..
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.