I Have to Pay The Sellers’ Taxes?
Not many people who are buyers of property in Canada are aware that they could actually become liable for the sellers’ taxes owing to CRA. This is as a result of Section 116 of the Income Tax Act.
The CRA wants to receive its share of the taxes owing from the sale of certain properties (Taxable Canadian Property like real or depreciable property) and when a non-resident of Canada sells this property, CRA worries it might not be able to collect the amount due to them. This is where Section 116 of the Income Tax Act comes in.
There are really 3 options both the buyer and seller have when the seller is a non-resident.
Option 1 – Seller Obtains Certificate of Compliance Prior to Sale
If the non-resident knows they will sell the property in the future at a certain date, they can notify CRA by filling out form T2062. This form will include a description of the property, who the purchaser is and the projected proceeds and ACB of the property. In order to receive the Certificate, the non-resident seller must attach either a) 25% of the capital gain amount from their potential sale or b) give CRA adequate security for the disposition to cover the capital gains tax owing. Once CRA is comfortable with one of these amounts, they will issue the Certificate.
The seller than shows this Certificate to the purchaser and the purchaser does not have to worry about withholding an amount for the transaction.
If the amount changes once the actual sale occurs, the buyer needs to do another form and post more payment if the amount owing is greater than originally thought.
Option 2 – Seller Obtains Certificate of Compliance After Sale
If the non-resident seller did not obtain the Certificate prior to sale, once the property is sold, they now have 10 days to file the T2062 with CRA. Using this method, the buyer must now withhold 25% of the purchase price, not the capital gain amount. This amount goes up to 50% if the property is depreciable property such as a rental property. If the buyer has not received their Certificate within 30 days after the month in which the sale occurred, the seller now has to remit the withheld amount to CRA to avoid liability by the end of those 30 days.
In order to obtain the Certificate in this instance, CRA will want the appropriate taxes payable or security against the amount owing. The buyer’s lawyer can remit the 25% of capital gain and then CRA will issue the Certificate. The buyer’s lawyer will then refund the difference to the seller from the original hold back (25% of total proceeds) and amount paid to CRA (25% of capital gain).
25% of the gain is always going to be less than 25% of the total proceeds. This means it is always more beneficial to obtain the Certificate prior to the sale, and not within the 10 day window period. You should also know it takes weeks and even usually months to obtain the Certificate so it will help to plan for filing the T2062 in advance.
Option 3 – No Certificate is Given
When no certificate is given to the buyer, they must perform necessary due diligence, known as “reasonable inquiry”, to ensure that they are buying from a Canadian resident or non-resident. If no due diligence was performed, the buyer is than liable for paying the withholding tax in the event the seller is a non-resident. This is why it is vital to perform the proper diligence on your counterparty in these types of transactions. Usually, the real estate lawyer should prepare a declaration for the selling party to sign saying they are resident or non-resident. This could satisfy the “reasonable inquiry”. Or the purchase document contains a warranty provision that the seller is not a non-resident when the contract is complete.
If the seller does not make a “reasonable inquiry”, they are liable for the taxes owing. Some exceptions to this liability are 1) the “reasonable inquiry” already stated above, 2) Treaty protected property such as sale of private corporation shares or capital distributions from a trust, and 3) Excluded property like mutual fund units or shares on a stock exchange. Any property that is excluded property or treaty protected property exempts the purchaser from liability and does not fall under the Section 116 compliance regime. However, buyers can never know exactly if these exclusions are met and might insist upon a Certificate in order to alleviate their liability.
General Comments
The non-resident is still required to file a Canadian income tax return by the usual April 30th date to determine the appropriate amount of tax. If the seller has overpaid CRA, they will be refunded the amount and if they owe more, they must pay that amount.
The non-resident will need an individual tax number to file the T2062 and tax return. This is a separate form called T1261 that has to be filed with CRA along with the T2062.
The onus is on the taxpayer to determine whether property is Taxable Canadian Property. CRA will not rule whether it is or not usually until after the transaction and forms are complete.
If seller does not obtain the Certificate of Compliance after the 10 day period, they will be charged $25 each day, up to a maximum amount of $2,500.
How does the Underused Housing Tax come in play here?
Once a Certificate of Compliance under Section 116 is filed to CRA, it will automatically trigger an underused housing tax review of the non-resident. If there are any deficiencies in the Underused Housing Tax review, CRA will not issue the Certificate until the Underused Housing Tax obligations and filings are fulfilled.
DISCLAIMER: The articles posted on TaxCrunch should not be considered specific advice to anyone readying. Please reach out to a professional advisor to seek guidance on any issues mentioned in this post before acting upon anything written here. All posts are time sensitive to what is law at the time written and are subject to changes in legislation.