Despite the COVID-19 pandemic, the Canadian real estate market and the stock exchange have seen unprecedented growth, prompting many to sell their properties or securities to secure maximum gains.
Nonresidents of Canada who are planning to dispose of Canadian properties, in particular, certain Taxable Canadian Property (TCP) or Taxable Quebec Property (TQP) should understand the filing requirements and tax consequences upon disposition.
What is a TCP and TQP?
Subsection 248(1) of the Income Tax Act (ITA) defines TCP to include:
- Real (or, in Québec – immovable) 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 (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
- 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
TCP excludes shares of corporations and certain other interests in entities that do not ‘directly or indirectly’ derive their value principally from Canadian real properties. However, a review of the entities holdings for the last 60 months would be required to ensure it did not derive more than 50% of its FMV from TCP at any relevant time, not just at the time of disposition.
The Quebec Taxation Act (QTA) defines TQP in section 1094 in a similar manner as the definition of TCP, in respect of property situated in Quebec.
Arguably, the most common TCP/TQP dispositions are of real estate located in Canada and interests in companies or partnerships, which derive their value from real estate, resource properties or mineral rights in Canada.
What are the tax implications?
Subsection 116(5) requires the purchaser to remit 25% of the purchase price within 30 days after the end of the month in which the property was acquired unless the purchaser has made reasonable inquiry and believes that the vendor is a resident of Canada, or the property would be exempt from tax under a tax treaty with another country.
This additional withholding burden can deter purchasers, generally in the residential property context, from dealing with nonresidents, so what can be done?
The nonresident disposing of TCP can relieve the purchaser’s withholding tax burden by obtaining a clearance certificate pursuant to section 116(2) or 116(4) of the ITA by filing Form T2062 or T2062A, and paying the calculated amount of the tax directly to the Canada Revenue Agency (CRA).
Obtaining a clearance certificate
Nonresidents must first obtain a Canadian tax identification number prior to submitting a request for a clearance certificate. This can take some time to process; the application should be submitted as soon as possible to CRA.
The nonresident may notify CRA of an impending section 116 disposition and apply for a clearance certificate, based on estimated proceeds, before the disposition occurs pursuant to subsection 116(1).
Where notification is not provided to CRA before the disposition, the nonresident must instead send CRA notice of the actual disposition no later than 10 days following the disposition, pursuant to subsection 116(3).
Upon receipt of notification and payment of the taxes, or provision of adequate security due, CRA will issue a clearance certificate, before the disposition under subsection 116(2) or within 10 days after the disposition under subsection 116(4). Taxes are calculated as 25% of any gain realized on disposition (subject to reduction based on a tax treaty).
CRA has been accepting notifications online through My Account, Represent a Client, or My Business Account since June 19, 2020.
Similar to the federal rules, section 1099 of the QTA requires notification to be filed with Revenue Quebec no later than 10 days after the date of disposition. A notification is made by filing Form TP-1097-V and supporting documentation. Quebec withholding tax is calculated as 12.875% of the capital gain in addition to any federal withholding tax.
A nonresident should obtain a clearance certificate even if the transaction results in a capital loss.
What are the consequences of non-compliance?
Obtaining a clearance certificate under section 116 is technically optional for the nonresident; however, choosing not to apply can have real financial consequences. Where CRA does not receive notification and, therefore, does not issue a clearance certificate, the purchaser is liable to withhold 25% of the purchase price (as opposed to 25% of the capital gain in the compliant scenario) and remit that amount to CRA on behalf of the nonresident.
Where a property was previously rented, and the disposition brings to light that this Canadian source income has been unreported, CRA may also request payment of any outstanding withholding tax on that rental income.
Nonresidents who provide late notification to CRA of the disposition (in excess of 10 days post disposition) will be liable to pay a penalty under subsection 162(7) of the ITA. This penalty is equal to $25 a day for each day the notification is late, with a minimum of $100 and a maximum of $2,500 and is a general penalty that applies to a number of different late filings in the ITA.
For property located in Quebec, subject to certain exceptions, failure to file a notification on time may result in additional Quebec penalties of $25 a day for each day the notification is late, up to a maximum of $2,500.
The monetary late penalty under 162(7) of the ITA or under the QTA are in fact not significant in comparison to other consequences of late filing. As mentioned above, where notification is not provided within 10 days of the disposition, the 25% withholding is calculated on the proceeds, for both federal and Quebec purposes, instead of on the amount of the gain. This could result in withholding tax applying when the disposition will in fact result in only a small gain or even a loss for the nonresident vendor.
Where the withholding is in excess of the actual tax liability, such as would be the case with a disposition that results in a loss, the nonresident will need to wait until their regular year-end to file a Canadian tax return and claim their refund. This increase in the withheld amount and the additional administrative burdens may result in CRA holding funds for an extended period of time without the benefit of interest accruing.
What other Canadian compliance may be required?
Generally, a nonresident who disposed of TCP is required to file a Canadian income tax return. Nonresident individuals must file their tax returns by April 30 of the following year in which the disposition took place and corporations must file their tax returns six months after the end of the taxation year in which the disposition took place.
In some cases a tax return may not be required if a nonresident has no prior or current year tax obligation and each TCP is either excluded property or a section 116 clearance certificate has been issued by CRA. As the withholding tax amount remitted may be higher than the actual tax due on disposition, nonresidents should still consider filing a tax return as they may be entitled to a tax refund.
Similar to the federal rules, a Revenu Quebec tax return should be filed to collect any excess tax paid. A personal tax return is due by April 30 of the following year in which the TQP was disposed of. For corporations, the due date is six months after the end of the taxation year in which the disposition took place.
Impacts of COVID-19
During COVID-19, CRA experienced an interruption in processing these requests.
Generally, when a compliance certificate is issued, a copy is also provided to the purchaser, which relieves them of their requirement to withhold tax on the purchase price. Otherwise, as mentioned above, where the purchaser does not receive the certificate within 30 days after the end of the month in which the property was acquired, they should remit withholding tax as 25% of the purchase price.
The delays in processing present challenges as the nonresident may have already notified CRA and remitted the appropriate tax.
CRA has provided some relief. Where the notification and payment procedures have been filed with CRA and a certificate has not been issued in a timely manner, the nonresident or the purchaser can request a comfort letter from CRA. The comfort letter will allow the purchaser to retain the tax withheld without interest or penalty until the certificate is issued.
Notify early for best tax outcomes
Given the highly active real estate market and stock exchange, CRA and the Revenu Quebec may be under significant pressure to issue a large number of clearance certificates for nonresidents disposing of TCP or TQP.
Nonresidents planning to dispose of their TCP or TQP should apply for a clearance certificate as soon as practical to avoid immediate cash flow impact and to give sufficient time to CRA and Revenu Quebec to process requests.
Purchasers of TCP and TQP from nonresidents should consider their withholding tax obligations as the tax authorities would generally hold them liable to withhold and remit tax from the proceeds distributed to a nonresident and it may be difficult for the purchaser to recover amounts not withheld upfront.
While CRA’s comfort letter procedure provides some relief of potential interest and penalties, it should not be relied upon as it does not necessarily serve to get proceeds into the nonresident’s hands faster.