Sale of Taxable Canadian Real Property

Under the ITA the Canadian government has the right to tax a non-resident’s sale of Canadian real property. The tax is calculated on either:

• the capital gain, or
• income realized on the sale of the real property.

As it is more difficult for the Canadian government to collect tax from a non-resident, the ITA also makes the buyer liable for a payment of tax on the sale (unless certain requirements are met) and allows the buyer to make that payment by withholding funds from the purchase price. To prevent the buyer from withholding those funds, the seller must obtain a clearance certificate which requires a payment to the Canada Revenue Agency (“CRA”) to cover the estimated tax.

Canadians who purchase real property from non-residents of Canada could be liable for taxes of up to 50% of the purchase price if they are unaware of their rights and obligations under section 116 of the ITA.

In addition to setting out the buyer’s remittance obligation, section 116 also sets out the non-resident seller’s compliance obligations. The rules in section 116 overlap to achieve the government’s goal of ensuring that non-resident sellers pay their tax.

Buyer’s Obligations

A buyer, wherever resident, who purchases a property from a non-resident individual or company is obligated to pay 25% of the purchase price to the CRA within thirty days after the end of the month in which the property was purchased. So, if closing occurs on July 15, the payment must be made by August 30. To assist with making this payment, the buyer is entitled to withhold an amount from the purchase price equal to the payment required by the ITA. As such, in all cases where the buyer is required to make such a payment to the CRA, the same amount should be withheld or the buyer will be left with a large bill and no funds to cover it. For certain types of properties, such as real property inventory (i.e., a non-resident developer selling new condominiums), the required payment is 50% of the purchase price. Often it is difficult for the buyer to determine what must be paid, and therefore how much should be withheld, so they must, along with their professional advisors, carry out investigations with the seller and the seller’s lawyer as to the appropriate amounts.

The buyer must pay the amount required by the ITA even if no tax is ultimately payable. So even if the seller is selling the property at a loss, the buyer should withhold because payment will still be required.

As the amount remitted does not necessarily represent the sellers’ actual tax liability, any excess can be refunded to the seller after the seller files a Canadian tax return to report the sale.

The buyer is relieved from any obligation to pay under the ITA if they receive a clearance certificate from the seller. The clearance certificate is issued by the CRA and confirms that the CRA has received the required information and adequate payment to cover the tax owed by the seller.

A seller can apply for a certificate either before or after the closing date. Normally, the seller will apply with the assistance of their accountant, after the contract of purchase and sale is executed and the purchase price is known so the gain from the sale can be determined.

Typically, withholding of funds will be carried out as part of the conveyancing process with the amount set out on the seller’s statement of adjustments. Though the ITA provides that it is the buyer who is entitled to withhold, it is typical that the lawyers or notaries acting for the seller and buyer will agree that the seller’s conveyancer will maintain the back-end on the appropriate professional undertakings.

Seller’s Obligations

A non-resident seller must provide the following information to the CRA within ten days of the closing date of a sale of real property unless the same information was provided to the CRA before the sale:

• the name and address of the buyer;
• a description of the property; and
• a statement of proceeds of the sale of the property and the amount of its adjusted cost base (the acquisition cost of the property and all carrying costs etc.).

if the seller, along with the preceding information, also sends the CRA an amount equal to 25% of the gain realized on the sale or sufficient security in lieu of that amount, then the CRA will issue a clearance certificate to the seller. Note that while the buyer may require a clearance certificate, the ITA does not strictly require a seller to obtain one.

The amount a buyer must pay to the CRA in the absence of a certificate and the amount a seller must pay to acquire a certificate are often different. If there is no gain on the property, a seller, by demonstrating that fact, would not have to pay any amount to obtain a certificate. In contrast, if no certificate was obtained, the buyer would be obligated to pay the CRA an amount equal to 25% of the purchase price.

After receiving the notification, supporting documents, and payment (if any is due), the CRA issues a clearance certificate to the seller. As the seller has already remitted the required amount (25% of the gain) to the CRA, the buyer is no longer obligated to pay the CRA and must stop withholding funds and release them to the seller.

Comfort Letter

The CRA’s policy is to issue the clearance certificate within 30 days of receiving notice and payment. In practice, however, the volume of applications and increasingly complex transactions makes the application process take much longer. In such cases, if the amount withheld by the buyer is held in escrow for the Receiver General and the CRA is notified, the CRA will usually issue a “comfort letter” before the buyer’s remittance due date (thirty days after the end of the month of the purchase), to allow the buyer to continue holding the funds until the clearance certificate is issued.

Penalties and Fines

If the buyer isn’t aware of their section 116 requirements, they may fail to withhold amounts from the purchase price and may be unable to pay the CRA. If they don’t make the required payment, they will become subject to penalties and interest. The buyer remains entitled to recoup the tax from the non-resident seller, but this may prove difficult.

As mentioned above, the seller is not required to obtain a clearance certificate by the ITA, but must still provide notice to the CRA regarding certain information about the sale within ten days of closing. Failure to do so results in penalties under the ITA of up to $2,500 per property sold.

Declaration of Residency – Seller

The Standard Contract of Purchase and Sale includes a provision (Clause 25) where the seller declares whether they are a resident or non-resident of Canada. In addition, the conveyancing lawyer or notary acting for the buyer will typically prepare a statutory declaration or certificate in which the seller declares whether they are or are not a resident of Canada at the time of signing the declaration or certificate and will maintain such status until after the Completion Date.

Assuming the seller completes the declaration in the Contract of Purchase and Sale and provides the additional certificate or statutory declaration prepared by their conveyancer, stating that they are not a non-resident of Canada, the buyer will generally not have any liability under section 116 unless they had reason to believe the declaration was not true.

Increasingly, conveyancing lawyers and notaries are refusing to have their seller clients sign non-resident statutory declarations or certificates produced as part of the conveyancing process, particularly in cases where there is some uncertainty. Failure to provide a declaration or certificate may result in a buyer’s lawyer or notary unilaterally imposing the withholding requirement under the ITA as they are entitled to under the ITA. So, whenever there is any question as to the residency status of the seller, the licensee for the seller should encourage their client to see their lawyer or notary as soon as possible, even before they list the property.

What if the seller has not always been a resident of Canada, but became a resident of Canada part way through their ownership of the property?

What if their residency status changes after the execution of the Contract but before closing?
What if they are retiring to Mexico right after the closing?
What if some but not all of the owners are residents of Canada?

Realtors should take great care in providing any advice to their seller clients as to their residency status and have them get professional advice from a lawyer or accountant before they sign a contract of purchase and sale.

Realtors should also be aware that if there is a non-resident’s withholding on a transaction, there may not be sufficient funds to payout the seller’s mortgage at closing thereby jeopardizing the transaction.

Realtors should confirm with their non-resident seller clients the approximate amount owed under the seller’s mortgage when taking the listing, so they can roughly determine if there will be sufficient funds to payout the mortgage given the expected sale price and the withholding amount.

Declaration of Residency – Buyer

The Standard Contract of Purchase and Sale was recently amended to include a provision (Clause 24) where the buyer declares whether they are a resident or non-resident of Canada. The new Foreign Entity Tax resulted in this addition to clause 24 to have the buyer declare their residency status.

The question was added to encourage an early discussion about the applicability of the new Foreign Entity Tax. You do not want to have that discussion at closing, but before the contract is entered into and clause 24 was added to encourage that discussion.

Foreclosure

When a property is being foreclosed, the foreclosing mortgagee will often not have any knowledge of the residency status of the registered owner. They typically refuse to take on the obligation of dealing with the residency status of the owner. They refuse to complete clause 24 and typically expressly provide in the addendum to the contract, that they are making no representation as to the residency status of the owner.

If buying in a foreclosure situation, where the foreclosing mortgagee has conduct of sale pursuant to an Order Nisi and is not willing to provide any representation as to residency, buyers should get legal advice prior to entering into the contract so their lawyer can attempt to address the residency issue in the contract. Failing which, the buyer will want to be advised as to the risks and costs in completing such a transaction without any residency declaration.

Where the foreclosing mortgagee knows the owner is a non-resident and expects that there will be a shortfall, the foreclosing mortgagee will often take title in the mortgagee’s name by obtaining an “Order Absolute”. The CRA’s view is that there need not be a withholding in such a case. The foreclosing mortgagee can then resell the property without any withholding as they are now the seller, and the foreclosing mortgagee will generally be a resident of Canada.

Goods and Services Tax

The Federal Goods and Services Tax (“GST”) applies to all real estate transactions unless there is a specific exemption.

The most common exemption is where the property is used as residential housing.

As most real estate transactions handled by real estate licensees involve the sale of used residential housing, licensees can be lulled into thinking they know all that there is to know about GST and real estate. That is generally a mistaken impression.

WARNING:
The applicability of GST to real estate transactions can be very complicated.

Licensees should be very wary of providing GST advice to buyers or sellers. Buyers and sellers should be advised to get GST advice from a lawyer or accountant in all but the most common of situations.

Project marketers should always insist that the GST provisions in the developer’s form of contract of purchase and sale have been approved by the developer’s accountant or lawyers.

It can get very complicated for example when the seller has carried out substantial renovations to the property prior to the sale