When shopping for a home or investment property, buyers don’t often give much thought to whom they are buying from. This month’s blog post is a cautionary tale that comes straight from one of my files.
As a general rule, when a person sells capital property such as real estate which has increased in value, there is a resulting capital gain. One-half of the gain is taxable in the year the property is sold at the seller’s marginal tax rate. Most sellers don’t think about the capital gains tax on the sale of their home, because there is a principal residence exemption (”PRE”). It is beyond the scope of this article to discuss the definition of “principal residence”, other than to say that generally a “family unit” can only have one principal residence in any year and at least one family member must live in the property.
When a Canadian resident sells real estate they must report the sale on their income tax return for the year the property is sold. Capital gains tax will be payable on the gain unless the property constitutes the seller’s principal residence in which case the PRE can generally be used to eliminate the capital gains tax.
The rules are different for non-resident sellers. Generally, non-residents do not have to file Canadian tax returns or pay Canadian income tax unless they earn Canadian-source income. Some types of income are subject to a non-resident withholding tax (that is, the income is taxed at source) whereas other types of income, such as capital gains from the sale of Canadian real estate, must be reported on a Canadian tax return.
Collecting the tax from someone living abroad can be practically difficult, if not impossible. That’s why the Canadian tax system, like other tax systems around the world, imposes an obligation on the purchaser of real property owned by a non-resident to withhold 25% of the purchase price and remit it to the Canada Revenue Agency (“CRA”) unless the non-resident seller has obtained a clearance certificate from CRA confirming that the non-resident seller has either paid the required tax or made satisfactory arrangements to do so. This is meant to ensure that non-residents who own and sell Canadian real estate pay their share of taxes on any capital gains. What happens if the purchaser closes the transaction without obtaining a clearance certificate or withholding the 25%? The purchaser may find himself personally liable for 25% of the purchase price!
This begs the question then, how is a purchaser supposed to know whether the seller is a non-resident? Well, the Income Tax Act requires the purchaser to make “reasonable inquiries” and have “no reason to believe that the seller is a non-resident of Canada”. The standard OREA (Ontario Real Estate Association) form of Agreement of Purchase and Sale provides that if the seller is “not a non-resident” of Canada, he will deliver to the buyer on closing a sworn declaration to that effect. Is the buyer entitled to rely on this declaration as evidence that the seller is not a non-resident? Does this constitute “reasonable inquiries”. The short answer is that it depends on the circumstances.
In the case of Kau v. The Queen (2018), the buyer purchased a Toronto condominium. The transaction was completed without either a clearance certificate or a 25% holdback on the basis of the seller’s declaration that he was not a non-resident of Canada. Nevertheless, the Court found the buyer liable for $92,000 of tax, being 25% of the $368,000 purchase price, because the facts and circumstances of the transaction suggested that the buyer and his lawyer after “reasonable inquiries” had reason to believe that the seller was not a resident of Canada. The buyer knew that the seller did not live in the condo and that it was an investment property. The buyer’s lawyer established through the usual searches of title that when the seller originally purchased the property his address for service was in California. This was the same address for service that the seller had given for the subject sale of the property. As well, the buyer’s lawyer was informed that the seller would be signing the closing documents in California. Further, the seller’s residency declaration was not a “sworn” or “solemn” declaration, meaning it did not carry the same weight as if made under oath. The judge felt that there were simply too many “red flags” to accept the declaration as evidence that the seller was truly not a non-resident.
Now, going back to my file. My client was purchasing a condominium in Toronto as an investment property. Neither my client nor her agent had met the seller. The seller did not live in the condominium but was holding it as an investment property. The seller signed both the Agreement of Purchase and Sale and the closing documents in another country. When the seller purchased the property, the closing documents were signed by way of power of attorney. However, the biggest red flag was that the seller provided us with a photocopy of her residency declaration which was not declared in the presence of a commissioner. Based on Kau, there were enough “red flags” to cause us to make further inquiries as to whether the seller was in fact a Canadian resident. In the end, the seller couldn’t provide us with any documentation to substantiate her claim that she was “not a non-resident of Canada” so we insisted on a 25% holdback. My client was not willing to accept the risk that CRA would find her liable for 25% of the purchase price, being well over $100,000.
What is the takeaway from this file? Always make reasonable inquiries of the seller when you have any reason to believe that the seller may not be a Canadian resident. It is not enough to simply rely on the seller’s declaration that he is not a non-resident of Canada. If there is any doubt in your mind as to the seller’s residency status, insist on a holdback. Otherwise, you may find yourself before the Tax Court of Canada explaining why you didn’t.
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