Under the Canadian tax system, an individual’s liability for income tax is based on his or her status as a resident or non-resident of Canada. A non-resident is only subject to Canadian income tax on income sources from inside Canada. That means that non-resident sellers who dispose of certain taxable Canadian property, including real property, situated in Canada, have to notify the Canada Revenue Agency (CRA) about the disposition either before they dispose of the property or within 10 days after the disposition. The CRA wants to ensure that they are able to collect the tax payable on the disposition of such property in Canada, and avoid the risk that the non-resident seller fails to pay Canadian income tax realized on the sale of the property. As a result we have the requirements discussed below.
When a seller knows that they will have an upcoming sale of real property, they should submit notice to the CRA of the proposed disposition. When the CRA has received either an amount to cover the tax on any given gain the seller may realize upon the disposition of the property, or an appropriate security for the tax, the CRA will issue a Certificate of Compliance to the seller (often called a Section 116 Certificate). A copy of the Certificate of Compliance is also sent to the buyer. If the seller does not apply for the certificate, and the buyer does not receive the certificate, the buyer through their real estate lawyer is required to withhold from the purchase price, and remit to the CRA, an amount up to 50% (usually 25%) of the purchase price on account of the seller’s Canadian tax. The certificate protects the buyer from any further tax liability for that particular disposition.
The seller should submit an application for a Section 116 Certificate at least 30 days before the property is actually disposed of to permit sufficient time for the CRA to review the transaction and verify that the seller’s payment or security is adequate. However, in practice the issuance of such certificate can take many months, so the earlier the seller can start the process the more likely it is that their sale transaction will close smoothly.
It’s imperative for a non-resident seller to be proactive about this process, because one part that is often misunderstood is that the requirement is to withhold a percentage from the entire purchase price not just from the sale proceeds. If 50% (or even 25%) of the purchase price is withheld while the parties wait for the CRA to provide the certificate, will there be enough left over to pay out the mortgage? To pay out the realtor’s commissions? If the certificate isn’t received in time for the sale’s closing date, it may mean the seller has to come up with the money to pay those things out of pocket in order to close the transaction.
It is a very good idea to have an experienced accountant assist with this process to make sure that the application is completed properly, submitted on time, and with all the required documentation.
When a buyer is purchasing property from a non-resident seller they will want to be aware of these requirements so that they can instruct their real estate lawyer to do the appropriate holdbacks if they have not received a Clearance Certificate by the time of the real estate closing. Obviously this matter is very important since a buyer will not want to find themselves in a situation where they are responsible to pay the seller’s tax liability, simply because they didn’t know about these requirements. The holdback requirements are a requirement of the Income Tax Act, it is not a term of the purchase contract that can be negotiated between buyer and seller or ignored altogether. For example, in certain situations a seller may propose that the buyer accept a lower holdback, or agree to proceed without the holdback, because they present information to the buyer showing that they will not owe any taxes, or that their tax liability will be very low. While this information may be absolutely correct, it is not up to the buyer to negotiate the holdback requirements, the requirements are a matter of law.
If there is any doubt about the residency status of the seller, the buyer should instruct their real estate lawyer to hold back up to 50% of the purchase price. This is because if, for any reason, the CRA believes that the buyer could have or should have known that the seller was a non-resident, or did not take reasonable steps to find out the residence status of the seller, then the Income Tax Act is very clear, that if the buyer has not received the Certificate of Compliance and does not withhold and remit the required withholding tax under section 116, he or she may become liable for the tax on behalf of the seller.
The buyer will have no obligation to pay the tax if after reasonable inquiry there was no reason to believe that the seller was a non-resident of Canada.
What is a “reasonable inquiry” as to the seller’s residence status? Unfortunately, there is no clear answer to this question, only that the buyer must take prudent measures to confirm the seller’s residence status. The CRA will review each case on an individual basis. The Tax Court of Canada also confirmed in Kau v. The Queen, 2018 TCC 156 (CanLii) that “reasonable” could be any range of actions, or inaction, determined by the pertinent factual context.
Usually, in Alberta real estate closings, the seller will provide to the buyer a certificate (or sometimes a statutory declaration) confirming that they are not a non-resident of Canada for income tax purposes. However, the Court has been clear that this may be insufficient if there are factual red flags that are potentially suggestive of non-residency. For example the seller’s address for service or address on title is outside Canada, or the seller is signing documents outside Canada. When in doubt, the buyer should gather all the information they can. Some examples (but in no way a complete list) of things a buyer might want to consider asking a seller if they suspect they are a non-resident:
The residence status of an individual is always a question of fact to be determined by taking into account all of the circumstances of an individual, so the buyer should take into account enough information to satisfy themselves that they have made a reasonable and prudent inquiry into the seller’s residency status.
It is also important to note that the buyer’s liability assessments are not subject to any time restrictions. Therefore, an assessment may be issued at any time the CRA becomes aware that a seller or buyer has not adhered to the above requirements.
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