When real property is sold by a non-resident of Canada, both the buyer and seller and their advisors should turn their minds to the provisions of section 116 of the Income Tax Act (the “ITA”). These provisions impose obligations and liability on both the buyer and seller, which should be addressed well before the date that the transaction is scheduled to close.
In brief, section 116 of the ITA provides that a non-resident seller may notify the Canada Revenue Agency (CRA) of a proposed disposition of property, such notice setting out, among other things, the estimated amount of sale proceeds to be received, as well as the adjusted cost base of the property. This notice must be given using form T2062, “Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property”.
If the non-resident has not given such notice to CRA prior to the completion of the transaction (or if the notice was given but the details surrounding the transaction have since changed), the non-resident must notify CRA of the disposition no later than 10 days after closing. In the event that the non-resident seller fails to do so, the seller may have to pay a penalty of up to $2,500, even if the sale of the property does not result in any tax owing.
Once CRA has received the non-resident seller’s notice and processed the request for a Certificate of Compliance, CRA will advise the seller of the amount of tax required to be paid and will issue the Certificate of Compliance upon receipt of payment.
If no Certificate of Compliance has been issued, section 116 provides that the buyer will be liable to pay 25% (or 50% in some cases) of the purchase price to CRA on behalf of the seller, within 30 days after the end of the month in which the property is acquired (“Remittance Deadline”). The buyer will be entitled to withhold this amount from the purchase price for the purposes of remitting this payment.
The Ontario Real Estate Association (OREA) standard form Agreement of Purchase and Sale, used in most residential real estate transactions in Ontario, contains a “residency” clause that is intended to address the requirements of section 116 of the ITA.
In most cases, the Certificate of Compliance will be issued by CRA after the transaction has been completed, as the tax is normally paid out of the proceeds of the sale. This means that the buyer’s lawyer will have to withhold 25% of the purchase price (or 50% for certain types of property) in trust (the “Holdback Amount”).
As the Certificate of Compliance may not be available prior to the Remittance Deadline, the non-resident seller may request a ‘comfort letter’ from CRA which will allow the buyer’s lawyer to continue withholding the Holdback Amount in trust beyond the Remittance Deadline, until otherwise instructed by CRA.
Once CRA has advised both parties of the amount of tax payable, the tax can then be paid from the Holdback Amount, and upon the issuance of a Certificate of Compliance, the balance of the funds can then be released to the seller.
Accordingly, by applying for a Certificate of Compliance well in advance of the closing date and requesting a comfort letter, the seller may be able to avoid a situation where the entire Holdback Amount is remitted to CRA by the buyer, and avoid having to wait until the seller’s tax returns are filed in order to reconcile this amount with the tax payable as a result of the sale.
Buyer’s Liability and “Reasonable Inquiry” into the Seller’s Residence Status
If the buyer could have or should have known that the seller is a non-resident, or did not take reasonable steps to investigate the seller’s residence status, the buyer may be liable under section 116.
The buyer will not be liable, however, if, after making reasonable inquiry, the buyer had no reason to believe that the non-resident person was not resident in Canada. In a typical purchase and sale transaction, a buyer relies on a statutory declaration made by the seller that the seller is not a non-resident of Canada for the purposes of section 116 of the ITA.
In certain circumstances, this declaration may not be available, making it challenging for the buyer to ensure that they are not exposed to liability under section 116. Where a property is being sold by a mortgagee under the power of sale, for example, the registered owner of the property is generally not involved or is uncooperative, and the mortgagee will likely not make any representations or warranties in the agreement of purchase and sale with respect to residency. It is then up to the buyer to make ‘reasonable inquiry’ of the seller’s residence status. What constitutes ‘reasonable inquiry’ is highly circumstantial.
In Kau v The Queen, 2018 TCC 156, the buyer of a condominium unit in Toronto was held liable for over $90,000 of tax under section 116 after the Tax Court of Canada determined that he failed to make reasonable inquiry as to whether the seller, who lived primarily in California, was a non-resident. This was despite the fact that the buyer’s lawyer had received a signed but unsworn statement from the seller, in which the seller stated that he was “not a non-resident of Canada within the meaning of section 116 of the Income Tax Act (Canada) and nor will [he] be a non-resident of Canada at the time of closing.” The Court held that this unsworn statement was insufficient to satisfy the purchaser’s obligation to make a reasonable inquiry.
The court further held that what is reasonable will be fact-specific. In Kau, the purchaser was aware that the seller owned the unit as an investment property and should have noticed that the seller had an address for service in California. Therefore, in those circumstances, the purchaser should have required more than an unsworn statement to confirm that the seller was not a non-resident. The court noted that the outcome would likely have been different had the seller made such a statement in a solemn declaration or under oath.
When the residence status of the seller is unclear, and no assurances are provided by or on behalf of the seller, a prudent buyer may try to err on the side of caution by withholding 25% of the purchase price and remitting the funds to CRA. However, section 116 only entitles the buyer to withhold funds if the seller is in fact a non-resident, and not simply because the buyer has not been able to confirm the seller’s residence status. In these circumstances, it is important for buyers to seek legal advice to ensure that their obligations under section 116 are adequately addressed prior to entering into a binding Agreement of Purchase and Sale.
There are some exceptions to the above, and how section 116 of the ITA applies will vary depending on the type of property being disposed of and the circumstances surrounding the transaction. The buyer and seller should consult with their respective lawyers regarding their particular transaction.
“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please contact a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.”