Individual Non-Residents Disposing of Canadian Real Estate Should Be Aware of Their Canadian Tax Reporting and Liability Requirements
The Canadian tax laws addressing the tax of individual non-residents disposing of Canadian real property are, although not drastically different from those imposed in similar transactions in some other jurisdictions, such as the United States and Australia, are quite rigorous. It is therefore important for non-resident investors selling Canadian real estate to be aware of their Canadian tax reporting and liability requirements.
Non-Residents Disposing of Canadian Real Estate: Seller Compliance Requirements
A non-resident is required to inform the Canada Revenue Agency (CRA) of any dispositions of Canadian real property, no later than ten days after the disposition occurs, unless the property is treaty-exempt property. The non-resident seller must complete Form T2062 and send it by registered mail to the CRA. Each non-resident joint tenant, tenancy in common, or co-owner of the property must file a separate Form T2062 to reflect their portion of the transaction. Depending on the type of property disposed of, the Form must be filed with a number of supporting documents, most of which provide key information related to the taxes owed. For example, supporting documents can include the sales agreement outlining the actual disposition, the purchase agreement indicating the original cost of the property, and information pertaining to the adjusted cost base of shares of a corporation owning the real property being sold. Based on these amounts, the Form calculates the net gain, which in recent historical years has been far more probable than a loss when selling Canadian real property, and multiplies this amount by 25% to determine the tax liability of the non-resident.
Non-Residents Disposing of Canadian Real Estate: Purchaser Compliance Requirements
A purchaser buying real property from a non-resident is required to withhold and remit 25% of the purchase price to the CRA, within 30 days after the end of the month in which the purchaser acquired the property, unless the non-resident seller has submitted Form T2062 and has in turn, together with the purchaser, been issued a clearance certificate which essentially confirms payment/security of the non-resident's tax liability.
CRA Processing and Auditing of Certificate of Compliance Applications
There are special CRA offices which process certificate of compliance applications (e.g. Form T2062), however, the applications are often sent to the taxpayers' local tax service office to be audited. During this process, it is not unusual for the CRA to also investigate whether the non-resident has a tax liability as a result of other income earned from the property, such as rental income, and subsequently initiate a more detailed audit and/or collections process.
Non-Resident Individuals Disposing of Real Property through a Canadian Holding Corporation
An individual non-resident cannot avoid these compliance and liability rules for disposition by holding a corporation which owns the property instead, and then subsequently disposing of the shares of the corporation (assuming it is not operating an active business). The Department of Finance has addressed this structure in the Income Tax Act, by including in the definition of Taxable Canadian Property, not only the real estate property itself, but also shares of a private corporation if within the last 60 months more than 50% of their fair market value were derived directly or indirectly from real property. The CRA has interpreted fair market value to be the highest price... obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length...". However, to prevent tax planning by adding debt to the corporation which holds the real estate property, the CRA's long-standing position has been that the gross value method should be used to value a corporation's shares. Thus, a taxpayer cannot incur debt in the corporation holding the property for purposes of decreasing the value of the shares of the corporation. This method is also consistent with the commentary on Article 13 of the OECD Model Tax Convention.
There is some potential relief in cases where the Canadian corporation held by the non-resident taxpayer disposes of the property on behalf of its individual owner(s), however this seems to only be the case when the withholding rate on dividends is very low, e.g. 5%. More specifically, there will be immediate tax savings when the resident corporation disposes of the property, because the tax rate on capital gains incurred by resident corporations is lower than the rate applied for non-residents. However, the total tax rate paid on the proceeds received can increase substantially when the non-resident decides to withdraw the proceeds from the corporation due to dividend withholding tax. Parties Currently or Previously Involved in a Transaction Comprising a Non-Resident Disposing of Canadian Real Estate Should Consider Contacting a Tax Lawyer If you are a non-resident who is planning on disposing of Canadian real estate, or a potential purchaser of Canadian real estate owned by a non-resident seller, you should speak to one of our experienced Canadian income tax lawyers regarding your income tax compliance requirements and for potential tax planning advice. If you are a non-resident who disposed of Canadian real estate in the past and did not report it, or a purchaser who bought Canadian real estate from a non-resident in the past and did not report it: you should seek legal advice regarding your tax liability in Canada and the potential benefits of a voluntary disclosure, to avoid penalties and interest, before you become a possible target of a CRA tax audit.
Tax Tips for Non-Resident Individuals Disposing of Canadian Real Estate
In summary, the Canada Revenue Agency addressed known tax planning loopholes for non-resident individuals who are not operating a related active business and are interested in disposing of their Canadian real property. After all, requiring the reporting of a disposition within ten days of the transaction with supporting documents through registered mail, and imposing potential liability on both parties, along with an immediate audit, are rigorous compliance elements only jointly applied in very few transactions in the Income Tax Act. However, there could be tax planning mechanisms which can be implemented in advance of a disposition, which can result in tax savings. For example, depending on the particular country the individual owner of Canadian real estate is a resident of, it may be beneficial for him/her to own Canadian real property through a Canadian corporation, and arrange for the corporation to dispose of the real property, while the taxpayer continues to (at least for a short period of time) own the shares of the corporation after the disposition.