On February 26, 2008, the Federal government tabled its Budget, in which it proposes a variety of tax changes, including measures to improve the efficiency of the compliance system for non-residents disposing of taxable Canadian property.
Under the existing provisions of the Income Tax Act (Canada) (the "Act"), where a non-resident vendor disposes of taxable Canadian property ("TCP"), other than "excluded property", section 116 of the Act requires the non-resident vendor to notify the Canada Revenue Agency ("CRA") of the disposition. Unless the vendor obtains a tax clearance certificate, the purchaser may become liable for the Canadian tax owing on the non-resident's gain. Accordingly, a purchaser will generally protect itself by withholding and remitting a portion of the purchase price in respect of the non-resident vendor's potential Canadian income tax liability.
In recent years, the section 116 compliance regime has been criticized as cumbersome and inefficient because it fails to take into account gains that are exempt from tax in Canada through the application of a bilateral tax treaty. Further, serious administrative backlogs in the length of time required by the CRA to review a transaction have had a negative impact on foreign investment in Canada. Non-resident vendors have faced long waiting periods, abundant paperwork and delays in receiving funds to which they are entitled.
The 2008 Budget seeks to streamline and simplify the compliance process, commencing with dispositions taking place after 2008. First, the Budget recognizes the impact of tax treaties by expanding the definition of "excluded property" to include "treaty-exempt property", the disposition of which is excused from the section 116 compliance process. A property will generally be considered "treaty-exempt property" if, at the time of disposition, the income or gain from the disposition of such property was exempt from tax in Canada by reason of the application of a tax treaty. Where the vendor and purchaser are related parties, the purchaser must notify the CRA of the sale within 30 days of the disposition.
The 2008 Budget also relieves purchasers of their liability to withhold and remit a portion of the purchase price where the purchaser concludes, after a "reasonable inquiry", that: i) the vendor is resident in a country with which Canada has a tax treaty; ii) the TCP would be "treaty-protected property" (as defined in section 248 of the Act) if the vendor were resident in that particular country; and iii) within 30 days of the acquisition, the purchaser notifies the CRA of the disposition in the prescribed form.
Finally, a related change exempts non-residents from the obligation to file Canadian income tax returns in respect of dispositions of TCP where: i) no tax is payable by the non-resident under Part 1 of the Act for the taxation year; ii) the non-resident is not liable to pay any amount under the Act in respect of a prior taxation year; and iii) each TCP disposed of by the non-resident in the year is either "excluded property" or a property in respect of which a clearance certificate has already been issued.
These measures are meant to alleviate the impediment to cross-border purchase and sale transactions created by the section 116 certification process, and to encourage foreign investment in Canada. However, as the proposals burden the purchaser with conducting a "reasonable inquiry" into whether the vendor is resident in a country with which Canada has a tax treaty, and whether the TCP would be "treaty-protected property", purchasers, particularly in arm's length transactions, may nevertheless choose to err on the side of caution and continue to withhold tax and require a compliance certificate from the non-resident, given the dire consequences to the purchaser if he or she is mistaken in this inquiry.