Section 116 – A Case Study

Volume No. 19-08

Author: Jeannie Lim, CA, CPA, TEP, MMPA
Editors: Peter Weissman FCPA, FCA, TEP and Matthew Cho CPA, CA, TEP

A non-resident of Canada is subject to Canadian taxation on gains arising from the disposition of taxable Canadian property (“TCP”).  TCP includes many items but the most common one we see in practice is Canadian real estate.  Many non-residents selling Canadian real property often discover the purchaser is withholding 25% of the gross proceeds pending receipt of a “compliance certificate”[1] from the non-resident.  In some cases, the withholding is 50%.  Our discussion today focuses on a non-resident’s reporting and withholding tax requirements under section 116 of the Income Tax Act (the “Act”) upon the sale of TCP and more importantly, how to reduce the withholding tax amounts. 

In this case study, a non-resident taxpayer (the “vendor”) is looking to sell rental property in Canada. The rental property consists of land and building.  For tax purposes, the land portion is considered to be a non-depreciable property while the building is considered to be a depreciable property.  It is important to distinguish between the two as the process is slightly different.

Sale of Land

At any time prior to a sale, the vendor may choose to report the disposition of the land to the Canada Revenue Agency (“CRA”)[2].  If such pre-disclosure is not made, the Act requires the vendor to report the land disposition to the CRA within 10 days of the sale[3] on Form T2062. If Form T2062 is filed after the 10 day deadline, late filing penalties of up to $2,500 can apply.

If Form T2062 is not filed with the CRA, or if it was filed but the CRA has not yet accepted it at the closing date, the purchaser must withhold 25% of the gross purchase price of the land and remit it to the CRA within 30 days after the end of the month in which the sale occurred.  However, this payment can be avoided if a comfort letter is obtained. If a comfort letter is issued by the CRA the purchaser can hold the required taxes (25% of the purchase price for non-depreciable TCP and 50% for depreciable TCP) beyond the remittance deadline until the CRA has completed its review of the certificate. Any excess taxes above the amount listed in Form 2068 can then be released to the vendor.

It can take more than 6 months for the CRA to process a compliance certificate application. Without a comfort letter[4], the purchaser must remit the full taxes to the CRA by the stipulated deadline and the vendor will have to wait until its tax return is filed and processed by the CRA to get its refund back.

If Form T2062 is accepted by the CRA, they will issue Form T2068 (commonly known as a compliance certificate) stating that the application was accepted and will request 25% of the capital gain amount (rather than 25% of gross purchase price) of the land sale.  Once the Form T2068 is issued, the purchaser can release any excess withholding taxes to the vendor and remit the required amount to the CRA.

Sale of Building

If the vendor does nothing regarding the building portion, the purchaser is required to withhold 50% of the gross purchase price of the building and remit it to the CRA within 30 days after the end of the month in which the sale occurred. We note there is no legal obligation for the vendor to report the sale.  

However, the vendor should report the disposition to the CRA using Form T2062A in order to reduce the 50% withholding requirement.  If the application is accepted, the CRA will issue Form T2068 outlining the required amount of taxes on the building sale.  The vendor can then forward the compliance certificate to the buyer. The buyer can then release the excess withholdings and remit the required taxes to the CRA.

The amount of taxes that is required by CRA as outlined in IC72-17R6 is 25% of the capital gain amount on the sale of the building plus the amount of taxes applicable on any recapture. If the actual recapture amount cannot be determined, the CRA will assume maximum recapture (i.e. as if the vendor claimed maximum capital cost allowance during the period of ownership).

Summary

If a non-resident disposes of a real property in Canada they should apply for a compliance certificate from the CRA and where necessary, a comfort letter.  Failure to do so could result in the purchaser remitting the full withholding required with the vendor having to wait until its tax return is processed to receive the excess withholdings back. 

If you have situations involving a non-resident disposing TCP, a Cadesky Tax representative would be happy to assist you.

 

[1] Colloquially referred to as a “clearance certificate”
[2] Subsection 116(1) of the Act.
[3] Subsection 116(3) of the Act.
[4] Although not technically correct, we have seen situations where buyers were willing to hold onto the required withholding taxes past the 30 day remittance deadline pending receipt of a comfort letter/T2068. Granted, CRA can apply a penalty on the buyer on the late tax remittance under subsection 227(9), however the CRA has not been actively enforcing this due to their backlog in processing compliance certificates.


TAX TIP is provided as a free service to clients and friends of Cadesky Tax.

The material provided in Tax Tip is believed to be accurate and reliable as of the date of posting. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.