Limiting Liability of Buyers for Taxes of a Non-Resident Seller
Section 116 of the Income Tax Act (the “ITA“) sets out the obligations of the seller and the buyer when the seller is a ‘non-resident’ for tax purposes, and sells real estate situated in Canada.
If a seller of real estate is a non-resident, the buyer must withhold 25% (or sometimes up to 50% depending on the type of property) of the purchase price of the property, unless a Certificate of Compliance (more about this below) has been provided by the seller before the completion date.
The policy reason for why the withholding obligation is imposed on the buyer (and not the seller) is because the Canada Revenue Agency (the “CRA”) wants to fend off the non-resident seller from evading taxes. If the seller is a non-resident and the buyer does not withhold the required amount (for example, the seller advises the buyer that they are a resident even though they are not), then the buyer becomes liable unless they can demonstrate they have made a “reasonable inquiry” as to the seller’s residency status. This is called the due diligence defense under section 116(5) of the ITA. The ITA is not very clear what “reasonable inquiry” entails, but case law suggests that it is fact-specific to each case depending on the circumstance (for example, see Kau v The Queen, 2018 TCC 156).
The ITA requires that the seller notify the buyer of their residency status upon the buyer’s reasonable inquiry.
A common mistake often made is that the seller will declare they are a resident of Canada on the basis that they are either a Canadian citizen or a permanent resident of Canada. This is a mistake because their immigration status under the Immigration and Refugee Protection Act (“IRPA”) is not determinative of their taxation status under the ITA. In other words, it is totally possible for the seller to be a Canadian citizen or a permanent resident of Canada under IRPA, yet be a non-resident of Canada under the ITA. If the seller is unsure about their residency status, they should seek advice from their personal accountant or tax lawyer (and not their real estate lawyer because they likely do not have expertise in tax law for determining taxation status). The determination of one’s residency status requires a detailed and thoughtful analysis. There is no single definition under the ITA as to what “resident” means, but rather it involves a list of factors to be assessed and balanced. To get a flavor of the complexity of this analysis, see Income Tax Folio S5-F1-C1, Determining an Individual’s Residence Status.
If it has been determined that the seller is a non-resident under the ITA, then the seller must either: (1) provide the Certificate of Compliance (also known as the tax clearance certificate) to the buyer before the completion date, or (2) file the form T2062 with the CRA within 10 days after the completion date to obtain the Certificate of Compliance. If the latter, the buyer must withhold the withholding amount—25% of the purchase price (not the net sale proceeds) or up to 50% if section 116(5.2) of the ITA applies [depreciable property, such as rental or business property]. Once the buyer (usually the buyer’s real estate lawyer) receives the Certificate of Compliance, they will remit the payable amount to the CRA and the remaining amount will be returned to the seller. Lastly, section 162(7) of the ITA provides that if the seller fails to apply for the Certificate of Compliance within 10 days after the completion date, the seller will be liable to pay a penalty of $25 for each day they are late in filing, with a minimum penalty amount of $100 and a maximum of $2,500.
Limiting Liability of the Buyer
When we act for a purchaser of real estate, we prepare a statutory declaration for the seller to sign, in order to satisfy the “reasonable inquiry” defence under the ITA, and we take additional steps if circumstances warrant further inquiry. If a seller is a non-resident, we holdback 25% (or more if required by the ITA) in our trust account until the seller’s lawyer or notary provides us with a Certificate of Compliance.
Coordinating Payment of Seller’s Taxes
When we act for a non-resident seller, we usually will encourage them to connect with their accountant before the completion date in order to arrange for the preparation and filing of a T2062 after the completion date. Receipt of a Certificate of Compliance can take a few months so obtaining one before the completion date is often not a possibility based on the common timelines in a real estate transaction. As part of the process for obtaining a Certificate of Clearance, the CRA does not issue one until all tax liabilities of the seller are met, so it is standard for the CRA to issue a letter requiring payment of taxes related to the sale. In that event, with the seller’s instruction and the consent of the buyer we will usually pay those taxes using the funds we held back in our trust account. Once paid, the CRA will issue the Certificate of Compliance and which we provide to the buyer’s lawyer or notary so that we can release the balance of holdback funds to the seller.