Withholding Tax for Non-Residents on Real Estate Sales
Over the years, Canada has been seen as an attractive place for foreign investors to purchase real estate due to its history of lucrative price appreciations. Unfortunately, Non-Residents are often unaware of the additional tax compliance rules that applies to them under the Canadian Income Tax Regime.
An individual’s residency status in Canada can have profound impacts on his or her tax obligations due to the differential treatment of Residents and Non-Residents under the Canadian Income Tax Regime. Canadian Residents must pay tax on worldwide sources of income, while Non-Residents are only liable to pay tax on Canadian Sources of income. Canadian sources of income for Non-Residents may include employment income, business income, and income earned through disposition of Canadian real estate.
What is a Taxable Canadian Property?
Non-Residents of Canada who plan on disposing certain Taxable Canadian Property (“TCP”) should understand the filing requirements and potential tax consequences upon sale of their property.
Under Subsection 248(1) of the Income Tax Act (“ITA”), RSC, 1985, c.1 (5th Supp.), TCPs may include:
- Real property situated in Canada;
- Property used to carry on a business in Canada;
- Shares of private corporations if, at any time in the last 60 months, more than 50% of the fair market value (the “FMV”) of the shares were derived directly or indirectly from Canadian real property;
- Shares of public corporations if at any time in the last 60 months, the taxpayer-owned at least 25% of the shares of any class; and more than 50% of the FMV of the shares were derived directly or indirectly from Canadian real property; and
- An interest in a partnership or an interest in a trust (other than a unit of a mutual fund trust or an income interest in a trust resident in Canada) if, at any time in the last 60 months more than 50% of the FMV of the interest was derived directly or indirectly from Canadian real property.
Although TCPs can encompass a large scope of properties, the disposition of real estate located in Canada are one of the most common TCP dispositions. Accordingly, it is essential for Non-Residents to understand the implications of Non-Resident Withholding Taxes when selling their Canadian properties.
For the purposes of this article, we will be discussing the tax considerations between a Resident Buyer and a Non-Resident Seller in a real estate transaction.
For tax purposes, an individual’s residency is generally based on the location where you spend most of your time, where you work, and where your immediate family lives. However, individuals who have significant ties to another country or spends a significant amount of time in more than one country may require a more detailed assessment to determine their residency status. For more information see our blog post here.
What is Non-Resident Withholding Tax?
Withholding Tax is a tax paid by the purchaser of a transaction as opposed to the Non-Resident seller. Under Subsection 116(5) of the ITA, the purchaser must remit 25% (or 50% depending on the TCP) of the purchase price within 30 days after the end of the month in which the property was acquired. Normally, the seller’s lawyer will undertake to provide the Canada Revenue Agency (“CRA“) with the required withholding tax upon completion of the sale. So it is usually the seller’s lawyer who ends up sending the withholding tax to the CRA.
The requirement for purchasers to withhold taxes can deter purchasers from dealing with Non-Residents. However, Non-Residents can relieve the purchaser’s withholding tax burden by obtaining a Clearance Certificate pursuant to subsection 116(2) or 116(4) of the ITA and paying the calculated amount of the tax directly to the CRA.
One notable advantage of obtaining a Clearance Certificate prior to the disposition is that taxes will be calculated as 25% of any net capital gain realized on disposition, as opposed to 25% of the total purchase price (or gross).
Consequences of Non-Compliance
The decision to obtain a Clearance Certificate under section 166 of the ITA is optional for the Non-Resident Seller. However, opting out of the Clearance Certificate can have substantial financial consequences.
Mainly, where the CRA does not issue a Clearance Certificate, the purchaser is liable to withhold 25% of the total purchase price (as opposed to 25% of the net capital gains) and remit the total amount to the CRA on behalf of the Non-Resident. This means that Non-Resident Sellers may face significant withholdings when the disposition will produce only a small gain or even a loss.
Furthermore, under subsection 162(7) of the ITA, Non-Residents will be subject to a penalty of $25 per day to a maximum of $2,500 for failing to notify the CRA of the disposition within the prescribed deadline (10 days after the disposition).
If you are interested in your tax obligations for purchasing or selling a property or would like assistance to determine your residency status, our team of experts can help! Contact us today for a free consultation to speak with one of our team of expert tax lawyers!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions, you should consult a lawyer.