Effective for transactions occurring after December 31, 2008, a new regime was established for compliance with section 116 of the Income Tax Act (Canada) (the “Act”). This regime was discussed in detail in one of our prior Tax Bulletins, which can be accessed by clicking here.

During the first year under the new regime, BLG has had an opportunity to deal with several transactions in which the application of the new regime has become an issue, and the following provides an overview of some solutions that may be available to parties.


In very general terms, section 116 of the Act applies when a vendor that is not resident in Canada disposes of taxable Canadian property, including, for example, shares in many private Canadian corporations. The vendor is generally required to apply for a certificate of compliance from the Canada Revenue Agency (the “CRA”). Unless a satisfactory certificate of compliance is obtained, the purchaser is required to withhold and remit 25% of the purchase price to the CRA (the “Withholding”).

In circumstances where a tax treaty would apply to exempt the non-resident vendor from tax in Canada on the disposition of the taxable Canadian property in question, this regime was often considered to be a frustrating administrative burden for both the purchaser and the vendor, as 25% of the purchase price would be held in escrow for periods up to several months before being released to the vendor. This problem can be especially frustrating to the parties when a significant portion of the purchase price consists of non-cash consideration, in which case the cash provided to the vendor at closing may be depleted significantly, or eliminated entirely, until a satisfactory certificate of compliance is obtained from the CRA.

New Regime

In some cases, the new regime may provide relief. Under the new regime, the Withholding is not required (1) if the property is, at the time of the disposition, “treatyexempt property” of the vendor, or (2) if subsection 116(5.01) applies to the disposition.

The first exemption, being that for “treaty-exempt property”, applies if the property is “treaty-protected property”, generally meaning property from which the sale proceeds would be exempt from Canadian income tax due to a tax treaty entered into between Canada and the vendor’s country of residence. In cases where the vendor and the purchaser are related, a notice must be filed with the CRA within 30 days of the purchase date.

The second exemption, being that under subsection 116(5.01), applies if three conditions are met:

  1. After reasonable inquiry, it must become clear to the purchaser that the vendor is resident in a country that has entered into a tax treaty with Canada;
  1. The property must be “treaty-protected property” of the vendor, if the vendor were resident in that particular country; and
  1. Within 30 days of the purchase date, the purchaser must file a notice with the CRA that contains specified information.

For arm’s length situations, there are a few key points worth noting.

Under the first exemption, the property must be “treaty-protected property” of the vendor. In many arm’s length situations, this places all of the risk on the purchaser. In order to rely upon the exemption, the purchaser must satisfy itself that the property actually is “treaty-protected property”, which may be difficult because many of the facts relevant to that determination may be solely within the vendor’s domain. Under this exemption, there is no safe harbour for the purchaser if the vendor is not resident in the country in which the vendor asserts that it is resident; an incorrect determination of the vendor’s residence could reverse the determination of whether or not the property is “treaty-protected property”, as a different treaty, or no treaty, may apply. Despite this, one advantage of the first exemption is that, where the parties are not related to one another, no notice must be filed with the CRA, which may ease the administrative burden if the purchaser is comfortable that the property in question is “treaty-protected property”.

The second exemption may provide greater comfort to a purchaser. The first requirement under this exemption is that the purchaser must, after making reasonable inquiries, conclude that the vendor is resident in a particular country pursuant to a tax treaty that the country has with Canada. Thus, after conducting sufficient due diligence and making an objective assessment of the residence of the vendor, the purchaser is entitled focus upon the property itself. For example, where the property is shares of a private Canadian corporation, most of Canada’s tax treaties exempt the gain as long as the value of the shares is not derived principally from real or immovable property situated in Canada. Often, this will be a straight forward determination. Finally, as noted above, in order to rely upon this exemption, a notice must be filed with the CRA within 30 days of the purchase date.

Our Experience

In our experience, the new regime has created a challenging business dynamic in situations where is relatively clear that the property would be “treaty-protected property”. Generally, vendors, who want to receive all of their money at closing, have taken the position that the exemptions under the new regime should be relied upon, and that no Withholding is required. Purchasers, on the other hand, have generally taken the position that, no matter how clear it is that an exemption would apply, they would prefer to engage in Withholding in order to eliminate any risk of an incorrect determination. We have seen this issue cause substantial conflict among parties. Three possible solutions, which can be used separately or together, are described below.

Solution 1: A Risk Discount to the Purchase Price

The vendor is asking the purchaser to take a risk. It is often a very small risk, but a risk nonetheless. It may be appropriate for the purchaser to be compensated for taking that risk. For example, the purchase price could be reduced by a small amount, such as 1%.

Solution 2: An Indemnity provided by the Vendor

Proceeding without withholding is for the sole benefit of the vendor. Accordingly, any associated risk should be for the account of the vendor. This can be achieved by requiring that the vendor provide the purchaser with an indemnity for any tax liability and related costs that could arise. While there are always issues associated with enforcing indemnities, it is better for the purchaser to have the indemnity, than not.

Solution 3: A Legal Opinion to the Purchaser on the Availability of 116(5.01)

Often, the most difficult aspect for the purchaser to get comfortable with is whether the vendor is in fact resident in the particular treaty country. The draftsmen of the new rules took this into account by giving purchasers a due diligence defence. The purchaser is not liable if, after reasonable inquiry, the purchaser concludes that the vendor is resident in the treaty country. By obtaining a legal opinion on the issue of residence, the purchaser puts itself in an excellent position to avail itself of this defence.

BLG has experience with all of these solutions. For example, we have provided subsection 116(5.01) opinions on several occasions. We have provided the opinion for our own purchaser clients and for third parties who have asked us to come in and resolve a deadlock between the parties and their counsel. In providing the opinion, BLG generally obtains representations from both the vendor and from the private corporation. It should be emphasized, however, that BLG will only be able to provide a favourable opinion if the right facts exist and suitable representations are available. For more information on these opinions, or on other aspects of this type of transaction, please contact the tax group in any BLG office.