Under §116 of The Canadian Income Tax Act (“CITA”), non-residents who dispose of certain taxable Canadian property, a/k/a “Canadian Taxable Property”, must notify the Canada Revenue Agency (“CRA”) of the pending sale either prior to the disposition or within 10 days after the closing. In addition, where the CRA has received either an amount to cover the tax on any gain the non-resident seller may realize upon the disposition of property, or appropriate security is provided for the tax, the CRA will issue a certificate of compliance to the seller-non-resident and a copy of the certificate is also delivered to the purchaser.
Where the purchaser does not receive such certificate, the purchaser is required to remit a specified amount, i.e., 25% of the gross sales price, to the Receiver General for Canada and is entitled to deduct the amount from the purchase price. Any payments or security provided by the non-resident seller and/or purchaser will be credited to the seller's account. A final settlement of tax will be made when the non-resident's income tax return for the year is assessed.
Canadian Taxable Property (“CTP”)
Canadian Taxable Property includes: (1) real property situated in Canada; (2) property used or held in, or eligible capital property in respect of, a business carried on in Canada;(3) designated insurance property of an insurer; (4) privately issued stock of a corporation resident in Canada; (5) shares of a non-resident, privately owned corporation that are not listed on a prescribed stock exchange if, at any time during the last sixty months(i) more than 50% of the fair market value of all the property of the non-resident corporation was made up of CTP, Canadian resource property, a timber resource property, an income interest in a trust resident in Canada, or an interest or option in such properties; and (ii) more than 50% of the fair market value of the shares was derived directly or indirectly from real property situated in Canada, Canadian resource properties or timber resource properties, or any combination of such properties; (6) publicly traded shares in a Canadian company if at any time during the last sixty months, 25% or more of the shares of the corporation belonged to the taxpayer and/or persons with whom the taxpayer did not deal at arm's length;(7) an interest in a partnership if, at any time during the last sixty months (i) more than 50% of the FMV of all property was of CTP, etc., and (ii) more than 50% of the FMV of the partnership interest was derived directly or indirectly from real property in Canada; (8) a capital interest in a Canadian resident trust (other than a unit trust; (9) a unit of a Canadian resident unit trust (other than a mutual fund trust); (10) a unit of a mutual fund trust if, at any time during the last sixty months, 25% or more of the units of the trust belonged to the taxpayer and/or persons with whom the taxpayer did not deal at arm's length; and (11) an interest in a non-resident trust if, at any time during the last sixty months, the trust was essentially comprised by CTP. Certain types of Canadian property are excluded from the definition of CTP.
Section 116 does not provide for treaty exempt status. However, the CRA permits a non-resident taxpayer to claim an exemption under a specific tax treaty at the time they file the notification of disposition. Non-resident sellers must state the applicable article and paragraph of the particular treaty that Canada has with their country of residence. To expedite the processing of the exemption, the necessary documentation to support the claim should be submitted along with the request. The documentation must be based on the particular tax treaty under which the exemption is claimed, and would include items such as proof of residency, or proof that the gain has been or will be reported in the vendor's country of residence.
Section 16 is a controversial part of the Canadian tax law since it is somewhat broad-sweeping in its application and imposes a substantial degree of notification, certification and advance tax requirements.
As recently reported in a just published Tax Notes article authored by Michael N. Kandev and Fred Purkey of Davies Ward Phillips & Vineberg LLP in Montreal, last year, the CRA attempted to limit the scope of §116, both on substantive and procedural rules. One new limitation is that “treaty exempt” property is no longer CTP. See U.S.-Canadian Income Tax Treaty, Article XIII(3). Another new provision, this one effective March 4, 2010, narrowed the definition of CTP to certain Canadian real or business property and interests in entities that have substantial investments, based on value, in Canadian real property or mineral properties. Under this narrowed framework, shares in a private Canadian corporation are CTP only to the extent that at any time during the five-year period preceding the disposition, they derived, directly or indirectly, more than 50% of their value from Canadian real property or Canadian resource properties.
Well-received by taxpayers and their advisers, the above changes were a significant change in the law in Canada. While the §116 reforms represented a favorable development for foreign investment in Canada, there are still certain rules that will continue to cause complexity and uncertainty. Among such problems noted by Messrs. Kandey and Purkey are the 5 year valuation lookback rule for shares and interests in partnerships and trusts
By far the main impediment to the intended results of the March 4, 2010, amendments has been the five-year valuation lookback for shares and interests in partnerships and trusts that is now the cornerstone of the amended definition of TCP.See Canadian Income Tax Act §248, ¶¶(d), (e). This 5 year lookback rule poses substantial uncertainty as to whether interests in private Canadian corporations holding ownership interests in real property are CTP or not period the business has not derived more than 50 percent of its value from Canadian real estate.
It is important to understand that a buyer of CTP from a non-resident, where the property is not “treaty exempt property”, still has potential liability in the transaction. As mentioned, the CRA must be notified of the sale, a tax clearance certificate must be obtained, and, in certain instances, the buyer must withhold and pay over within 30 days of the closing generally, 25%f the gross purchase price of the property. Messrs. Kandey and Purkey warn that if the purchaser assumes incorrectly that the sale was exempt from tax on the erroneous belief that the subject property is not CTP, the CRA, in its view, is likely to turn first against the purchaser. So, its “caveat emptor” to the purchaser of Canadian situs property from a non-resident. Reasonable cause does not appear to be a defense to the purchaser. Compounding this problem is that the purchaser’s liability, under CITA § 116(5), does not appear to be subject to a particular statute of limitations. This can have major impacts on successor or transferee liability let alone buyers of companies which have purchased assets from Canadian non-residents.
Obviously, it is important to seek the advises of a Canadian tax advisor when this issue arises. There are also potential treaty issues involved, for example, if a U.S. owner of tax exempt property is trying to sell Canadian property and the buyer is resistant to accept such status for whatever reason. Witholding 25% of the gross sales price on an exempt sale (by treaty) where the buyer stubbornly refuses to accept a treaty exemption certificate statement will drive up the non-resident seller’s compliance costs. A U.S. tax adviser can advise U.S. persons on treaty issues that impact on the presence of tax exempt treaty property. Lurking in the background for the U.S. seller of CTP are foreign tax credit issues.