Avoid unexpected tax on real estate purchases

Advisor's Edge

2018-10-15


Non-resident clients have different tax considerations than their Canadian-resident counterparts.

For instance, clients who are non-residents may be subject to withholding tax on Canadian dividends received in their non-registered portfolios. Similarly, if they have an RRSP or RRIF, non-resident withholding tax will generally apply to their RRSP and RRIF withdrawals.

Non-resident clients who realize a capital gain on the sale of securities or mutual funds in their non-registered accounts, however, do not have any tax withheld on such gains since they are not subject to Canadian income tax.

The rules are quite different when it comes to a capital gain arising on the sale of Canadian real estate realized by a non-resident. Such gain is subject to Canadian capital gains tax and must be reported on a Canadian return.

Collecting the Canadian tax owing from someone living abroad, whether in the U.S. or overseas, could be practically complex, if not impossible. That’s why the Canadian tax system, like others around the globe, has a special rule: if there is a gain from the sale of domestic real estate by a non-resident vendor, the purchaser of the property may be responsible for the capital gains tax.

To this end, the Income Tax Act requires the purchaser to withhold 25% of the purchase price from a non-resident unless the vendor has obtained a clearance certificate from CRA indicating that the non-resident has made appropriate arrangements to pay the tax.

If the non-resident doesn’t get a certificate, the Canadian resident purchaser is responsible for the 25% tax owing on behalf of the non-resident unless “after reasonable inquiry the purchaser had no reason to believe that the non-resident person was not resident in Canada,” the act reads.

A recent tax case (Kau v. the Queen, 2018 TCC 156) illustrates the danger of the purchaser failing to withhold the tax.

In June 2011, the taxpayer purchased a Toronto condominium unit from an “apparent non-resident of Canada.” The transaction was completed without a clearance certificate and without the taxpayer withholding 25% of the purchase price. The taxpayer thus found himself in Tax Court, liable for $92,000 in taxes (25% of the $368,000 purchase price).

The taxpayer was aware from a prior visit to the condo that the vendor did not live there and that it was an investment property. The taxpayer retained a lawyer who established, through searches and other preparation work for the closing of the transaction, that the vendor had purchased the property in 2009, when his address for service was in Danville, California.

This was the same address for service the vendor gave for the sale of the property. As well, the taxpayer’s lawyer was informed that the vendor would be signing the closing documents in California.

Just prior to closing, the vendor signed a one-sentence, unsworn statement before a California notary public, stating, “I am not a non-resident of Canada within the meaning of […] the Income Tax Act (Canada) and nor will I be a non-resident of Canada at the time of closing.”

The judge found it curious that the notary stated only that this statement had been “DECLARED before me.” There was no reference to the statement being either a “sworn” or “solemn” declaration or that the statement had been declared under penalty of perjury.

This contrasted with another declaration given the same day, before the same California notary public, regarding certain “HST matters” in which the vendor made a solemn declaration.

The issue before the court was whether the taxpayer, through his lawyer, could reasonably have concluded that the vendor was, in fact, resident in Canada.

The judge felt that there were simply too many red flags to accept the unsworn declaration as evidence that the vendor was not a non-resident. The taxpayer could have asked “simple questions” about the vendor’s permanent address or for a copy of the vendor’s driver’s licence.

In finding the taxpayer liable for the tax, the judge concluded that the law “calls for and deserves more than a brief, baldly stated affidavit or solemn declaration when there are factual red flags potentially suggestive of non-residency.” As the judge further pointed out: “The matter should then be pursued.”