Non-residents of Canada who dispose of certain “taxable Canadian property” (“TCP”) may be subject to tax under the Income Tax Act (the “ITA”). Where a purchaser knows (or ought to have known) that a vendor is a non-resident, the purchaser becomes liable for the payment of a withholding tax under section 116 of the ITA. Section 116 is necessary from a policy perspective. In the absence of section 116, the Canadian government has no direct jurisdiction over a non-resident vendor (the “vendor”) to collect tax on capital gains on real estate in Canada.
Depending on the nature of the real estate, section 116 requires the purchaser to withhold and remit up to 50% of the entire purchase price to the Canada Revenue Agency (the “CRA”) and deduct the amount from the purchase price. The amount withheld is credited to the purchaser in respect of the vendor’s liability under the ITA. The amount withheld must be remitted to the CRA within 30 days after the end of the month in which the sale closed.
If the purchaser fails to comply with the non-resident withholding tax regime, it becomes liable for the amount that should have been withheld. There is no limitation period for 116(5) liability to be assessed. As well, failure to pay imposes interest and attracts a penalty on the unremitted amounts.
Due Diligence Defence
Section 116 of the ITA provides for a “due diligence” defence, which applies if the purchaser did not know that the vendor was a non-resident. A purchaser can protect itself from liability for the withholding tax imposed by section 116 if the purchaser has taken reasonable steps to determine that the vendor is not a non-resident. This defence only applies if the purchaser did not know the vendor was a non-resident, but not if the purchaser did not know that the property was TCP.
Section 116 Certificate
Another way the purchaser can protect itself from liability pursuant to section 116 is by requiring the vendor to provide a Certificate of Compliance for Non-Resident Vendors (the “Section 116 Certificate”). A Section 116 Certificate is an alternative to the withholding and remittance requirement of the purchaser. The Section 116 Certificate is a certificate issued by the CRA confirming that the vendor has paid the income tax arising from the sale of the property.
In order to be entitled to a Section 116 Certificate, the vendor must remit 25% of the expected capital gains on the sale of the property. Alternatively, the vendor can provide security satisfactory to the CRA to cover the anticipated capital gains liability. When the CRA has received either an amount to cover the tax on any gain the vendor may realize upon the disposition of property, or appropriate security for the tax, the CRA will issue a Section 116 Certificate to the vendor. A copy of the certificate is also sent to the purchaser.
Section 116 Certificates get issued with a “certificate limit”, which is the maximum permitted by the CRA for the consideration of that sale. Where the CRA has issued a Section 116 certificate, the purchaser is entitled to forego the withholding and remittance requirement of section 116 of the ITA and pay, as consideration for the property, up to the “certificate limit”.
The CRA will credit any payments made or security provided by the parties pursuant to section 116 to the vendor’s account. A final settlement of tax will be made when the vendor’s income tax for the year is assessed. If the portion of the sale proceeds diverted to the CRA from the proceeds of sale pursuant to section 116 exceeds the amount of income tax payable, the vendor can apply for a refund after closing when the vendor files its income tax return for the year in which the closing takes place.
If you have any questions regarding section 116 of the ITA, please contact one of the lawyers in our Corporate/Commercial Practice Group.