By Emily Yeow, Associate Lawyer, Real Estate, Corporate, and Estate Planning
*This information and all references included below are intended for real estate professionals and licensed realtors although purchasers and sellers of Canadian residential property may find this helpful.
When you represent a seller or buyer in a residential real estate transaction, you should consider and be alert to the possibility that up to 25% of the sale proceeds might have to be withheld and paid to the Canada Revenue Agency (“CRA”). Withholding tax is a concept that refers to the need by the purchaser to holdback (i.e., retain) 25% of the gross sale price of non-rental residential property from the seller on closing or 25% of the gross sale price plus 50% of the building value where the property is used for rental purposes. Under Canada’s Income Tax Act (“ITA”) and its regulatory regime, if the seller is a “non-resident” of Canada, then both sides must act cooperatively to comply and avoid (i) the seller facing penalties, and (ii) the purchaser having the CRA file a lien against title to their newly acquired property. In this article, I outline the key components of these rules for non-rental residential property, how to spot when the rules apply, compliance, and what you can do to protect yourself and your clients from adverse consequences.
Withholding Tax and Why it Matters
If a “non-resident” (see below) is the seller of property in a transaction, then the withholding tax rules apply. In that case, the seller is responsible for reporting on certain aspects of the deal to the CRA and the purchaser is required to withhold a portion of the sale price. There are also important timing restrictions that apply, beyond which, the seller is at risk of paying penalties. Remember that, if you act for the seller, the seller makes legally binding promises and representations in the standard form agreement of purchase and sale (“APS”) as to his/her residency status.
The purchaser is also at risk if the withholding tax is not retained and remitted to the CRA. The CRA has the statutory power to register a caveat or file a lien against title to purchaser’s property after closing if the tax is not paid. There is, thus, a knock-on effect should a purchaser’s realtor fail to advise their client of the rules applying. Clients should be made aware of this early in the process of concluding the transaction and put on notice to work with their lawyers to apply the appropriate measures to avoid these outcomes.
Who is a “non-resident”?
Just because your client is a Canadian citizen does not mean that, for ITA purposes, they are a resident of Canada. Simply speaking, a “non-resident” is any person who is not a Canadian resident under the ITA. This sounds a lot simpler than it sometimes turns out to be. Residency status is determined by looking at a constellation of factors, however, there are some that are more important than others. The key consideration is whether the seller has significant connections to Canada such as whether they are a citizen or permanent resident with: (i) a prior home or residence in Canada, (ii) they have a spouse or common law partner, or (iii) children or other dependents based in Canada. If these facts are true for the seller, then the seller may be a resident. You should consider other aspects of the seller’s connections to Canada and request the seller to confirm these details prior to concluding the APS. For example, look to whether the seller has a Canadian driver’s license, provincial or territorial health insurance, Canadian bank accounts, credit cards, cars, or household items located in Canada as well as where their employer is based. What matters is the extent and quality of connections of a person’s relationship to Canada.
Non-resident sellers are required to obtain a clearance certificate from the CRA to avoid the application of the withholding tax rule. The ITA stipulates that the form be submitted either from the date the APS is signed or, at the maximum, within 10 days after closing to avoid liability for penalties. The CRA will only issue a clearance certificate once the seller files a form T2062 with the CRA that requires specific information regarding the transaction to be reported. This includes:
- the purchase price and date of sale
- the seller’s social insurance number or business number if a company
- the seller’s address, date of birth, and contact information, (iv) the date the seller became a
- the date that the seller originally purchased the property
- co-owner information (if applicable
- the location of the property
- the original cost of the property and the value of any work done to it
- income information earned on the property
If the certificate is not obtained prior to closing, then the purchaser’s lawyer must retain 25% of the sale proceeds pending receipt by the seller’s lawyer of a comfort letter from the CRA. This letter confirms the submission of the form and that the seller is up to date on his/her tax liabilities. Once this is received, the purchaser’s lawyer can then issue the retained amount to the seller’s lawyer who withholds the funds in trust and pays the same to the CRA on behalf of the seller. If this step is not completed, the seller can be penalized up to a maximum of $2,500 ($25 per day with interest). The seller can be liable for the penalty even if the CRA later concludes that the seller is not outstanding on his/her tax liability.
The buyer cares whether these steps have been taken because he/she is at risk of the CRA registering a lien against the property following closing. As required by the ITA, even if the seller fails to obtain the clearance certificate and lives outside of Canada, he/she is still obliged to report the transaction and his/her income every year. This may trigger the attention of the CRA with respect to the withholding taxes. In this event and if the seller is unavailable, then the CRA can enforce a lien against title to the property placing the purchaser at risk of default with his/her financing commitments. Typically, mortgage financing prohibits the borrower-purchaser from creating or allowing additional encumbrances to be registered on title. If this is an “event of default” within the terms of the mortgage documents, then lenders can typically accelerate (i.e. demand) that the purchaser pay the full balance of principal and interest then outstanding. Such an outcome or eventuality is financially onerous and concerning for your purchaser clients. There is, thus, every reason to be on guard to these risks no matter who you represent in a transaction.
Despite this, there is good news for non-resident sellers. The seller may receive some of the remitted (withheld) money back in pocket. When a non-resident seller files his/her annual tax return, he/she is permitted to claim a deduction reducing the total withholding tax liability from 25% of the sale price to 25% of the capital gain realized on the sale. Further deductions for transactional costs including legal fees and commissions paid are also allowed. Where this occurs and applies, the CRA will issue a refund of the difference between the amount initially withheld and the amount of liability then due.
Tips to Protect Yourself and Your Clients
- Firstly, encourage your vendor clients to file the T2062 form as far in advance as possible if you think they are likely a non-resident of Canada or to seek the advice of a lawyer if unsure as to their residency status. On average, the CRA takes anywhere from 6-12 weeks to review submissions and issue the necessary comfort letter. However, in the existing Alberta real estate market, this may not be possible or practical given the timing of your involvement in a sale or purchase. If so, clients should immediately be informed of the need to take expedited action if their residency is unclear since the seller must apply for the clearance certificate within 10 days of closing at the latest.
- Highlight to vendor clients that they will be making legally binding and enforceable promises therein that they are a resident of Canada. If the seller later turns out to be a non-resident, the purchaser can sue the seller for breach of warranty under these provisions. If your client is a non-resident, then you have the option of including additional terms in the relevant section of the APS whereby the purchaser waives their ability to enforce the seller’s warranty as to residency status. Contact a lawyer who can help draft the necessary language into the agreement.
- Following from 2. above, promptly inform the client’s lawyer or legal counsel of the seller’s non-residency status. Legal counsel will need to draft the required documentation and statutory declaration to make the conveyancing process as smooth as possible and to minimize your client’s risk of litigation from the purchaser.
- Failure to conduct sufficient due diligence as to your clients and counterparties may put you at risk of facing disciplinary sanctions and litigation for malpractice/negligence. Your ethical obligations require you to use proper know-your-client procedures to verify identity and to exercise competence in carrying out your obligations. A seller or purchaser may institute a formal complaint to the Real Estate Council of Alberta if they suffer the consequences outlined in this article that subjects you to investigation or sanction. Further, the law requires you to exercise a professional degree of care, skill, and attention to your transaction. You could also face litigation or civil suit if you actively conceal, omit to investigate, or inform the seller or purchaser of these rules applying. Therefore, it is always best to use standardized procedures compliant with your ethical duties when engaging a new client and to exercise caution by referring clients to seek legal advice if you are ever in doubt as to your client’s or the counterpart’s residency status. Where you do this, make sure to document your discussions with the client in writing where you have informed them of the rules. Such efforts document your compliance and the steps taken by you to exercise appropriate care.