A non-resident is generally taxable in Canada on the disposition of Canadian real estate. It is more difficult for the Canada Revenue Agency (CRA) to collect tax from a non-resident, so there are additional provisions to ensure the tax is pre-paid to protect against the risk of the vendor absconding and evading Canadian taxation.
Under subsection 116(5) of the Income Tax Act (“the Act”), the purchaser of the real estate must withhold tax (often 25 percent, but in some instances 50 percent) and this must be paid directly to the CRA. Alternatively, the withholding tax can be avoided if the vendor obtains a Section 116 Certificate and provides the certificate to the purchaser of the property. The CRA issues a Section 116 Certificate if the vendor pays their required tax to the CRA or posts adequate security.
The above mechanisms work well if the vendor declares they are a non-resident. If the vendor is a non-resident, but claims they are a Canadian resident, the purchaser of the property may not be alert to the fact that they may have additional obligations under the Act. If the purchaser does not know the vendor is a non-resident, they would likely have no reason to request a Section 116 Certificate or withhold the tax. Accordingly, subsection 116(5) still applies which imposes a liability (the amount of tax that should have been paid) on the purchaser if they fail to withhold the tax.
Paragraph 116(5)(a) provides a due diligence defence for the purchaser if “after reasonable inquiry the purchaser had no reason to believe that the non-resident person was not resident in Canada”.
There has been very little jurisprudence on the purchaser's liability where the non-resident does not disclose their non-residency. The single case heard by the Tax Court of Canada on this issue was in Kau v. The Queen 2018 TCC 156.
In Kau, the purchaser acquired a Toronto condominium unit. The purchaser knew that the vendor did not live in the condo and that it was an investment property. The purchaser also knew that the address for service of the vendor was in California. The vendor provided an unsworn statement before a California notary public stating “I am not a non-resident of Canada within the meaning of section 116 of the Income Tax Act (Canada) and nor will I be a non-resident at the time of closing”. The vendor also provided a solemn declaration regarding HST matters that they were not a non-resident. The purchaser took no further steps to ascertain the residency of the vendor.
The Tax Court said where there were “red flags” suggesting non-residency of the vendor, more than a basic inquiry of the residency status must be undertaken. The taxpayer in Kau was unable to rely on the due diligence defence under paragraph 116(5)(a) as the Tax Court decided that the taxpayer had not undertaken a “reasonable inquiry”.
The following suggestions can be taken from the Tax Court to demonstrate a “reasonable inquiry” if the vendor claims Canadian residency and “red flags” suggesting otherwise are present:
- Obtain a sworn affidavit that the vendor is a resident of Canada;
- An affidavit by the vendor should address the “red flags” specifically;
- If responses to questions raise further concerns, follow-up questions can be appropriate;
- Asking for a copy of the vendors driving license (note: lawyers are often reluctant to provide this, despite what the court said);
- Asking for the vendors permanent address, rather than their temporary address.
The CRA in a technical interpretation of the provision has also said that if there is “any other indication of the vendor's residence outside Canada”, that a “statutory declaration” stating the vendor is not a non-resident is not sufficient by itself to satisfy the “reasonable inquiry” test.
As frequently in law, what is a reasonable inquiry can only be determined by the specific facts of each transaction. If the “red flags” are stronger to suggesting non-residency, it would be apparent that a greater “inquiry” needs to be undertaken for it to be considered “reasonable”.
Ultimately, section 116 is an onerous provision for purchasers of property. Taxpayers in Canada purchasing property should be alert to any “red flags” suggesting non-residency and make additional inquiries to ensure they avoid the potential liability under section 116.
Importantly, if you are the purchaser, make sure you retain evidence of all steps that were taken to ascertain the residency of the vendor – it will be invaluable if the CRA attempts to tax you under section 116 later.
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.