Tax Law – Patrick Westaway
Non-residents of Canada who sell Canadian assets must determine whether such sale gives rise to a Canadian tax liability. If it does, it is important to obtain what is colloquially called a section 116 certificate, in reference to the governing provision of Canada’s Income Tax Act.
What kinds of property are taxed?
Canada claims jurisdiction to tax non-residents on sales only of “taxable Canadian property” (“TCP”). TCP generally includes Canadian real estate, assets used in a business in Canada or private company shares (or interests in a trust or partnership) that derive more that 50% of their value from Canadian real estate (or certain resource properties) at any time in the past five years. Shares of a public company or mutual fund are treated the same as private company shares if the taxpayer together with non-arm’s length persons owns 25% or more of the issued shares or trust units.
What is the relevance of Canada’s tax treaties?
TCP used to include all private company shares, which were then exempt under Canada’s tax treaties provided that they did not derive their value from Canadian real estate, as above. Section 116 certificates were required in those situations in order to invoke the treaty exemption and avoid the tax. Now that treaty-exempt categories of assets are generally excluded from the definition of TCP to begin with, the reason for obtaining a section 116 certificate is to reduce rather than avoid the amount of Canadian income tax on the sale.
What is the benefit of a section 116 certificate?
In the absence of a section 116 certificate, the purchaser is required to withhold and remit 25% of the purchase price. Since the Canada Revenue Agency (“CRA”) will have no information as to the vendor’s cost base in the assets, this 25% rate applies to the full amount of the purchase price rather than to the amount of the capital gain alone. If the vendor obtains a section 116 certificate, it will pay to the CRA tax only in the amount of 25% of the capital gain.
How do I apply for a section 116 certificate?
Form T2062 is to be filed with the tax services office—“TSO”, as distinct from the tax “centre”—for the area in which the property is located. If the vendor is not registered for Canadian income tax purposes then the vendor must so register by filing Form RC1 at the same time as the T2062. The supporting information to be filed with the T2062 varies according to the nature of the property and vendor. A checklist is attached to the T2062 at http://www.cra-arc.gc.ca/E/pbg/tf/t2062/t2062-08e.pdf. In general, the vendor must provide identification and evidence of their cost base and anticipated sale proceeds.
As a practical matter, a vendor may not have the funds with which to pay the tax until the sale proceeds are received on closing. This creates a problem since the section 116 certificate is not issued until the tax is either paid or security acceptable to the Minister of National Revenue is given therefor. This is addressed by filing the T2062 and requesting a comfort letter in advance of the section 116 certificate. The comfort letter identifies the amount of tax payable and relieves the purchaser of liability in excess of that amount. The amount withheld and remitted is then the correct 25% of the capital gain rather than 25% of the entire purchase price. The purchaser then has 30 days following the end of the month in which the sale occurs to remit the funds and the section 116 certificate is issued following payment.
Failure of the purchaser to meet these obligations causes the purchaser to become liable for the tax, in which case the purchaser must then pursue civil remedies to recover against a vendor who may then have no further assets in Canada.
* * This article is intended only to inform or educate. It is not legal advice. Be sure to contact a lawyer to obtain legal advice on any specific matter.
Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.