In a real estate transaction, one issue that can create unexpected complications is the residency status of the Seller. Where a Seller is a non-resident of Canada for tax purposes, Section 116 of the Income Tax Act will apply.

Section 116 is intended to ensure that Canada can collect tax that may be payable by a non-resident Seller on the disposition of taxable Canadian property, including Canadian real estate. Although this may appear to be a Seller-side tax issue, it can directly affect the Buyer, the closing process, and the release of sale proceeds.

If the Seller is a non-resident, the Seller is required to notify the Canada Revenue Agency and apply for a Certificate of Compliance. This is commonly done using the applicable CRA form, such as Form T2062 or T2062A, depending on the nature of the property. The Certificate of Compliance confirms that CRA has been notified and that the required tax payment or acceptable security has been addressed.

The practical issue is timing. A Certificate of Compliance is not always available before the Completion Date of the sale transaction. If the Certificate of Compliance is not available, the Buyer is be required to withhold funds from the amount otherwise payable to the Seller in order to protect against potential liability of the Seller to the CRA. For Seller occupied residential transactions  the Buyer’s requirement to withhold and the resulting exposure to the Buyer is 25% of the purchase price. However, for certain types of property, including depreciable property, business-use property, inventory, or Canadian real property that is not capital property, the requirement to withhold and the resulting exposure to the Buyer is 50% of the purchase price.

This is why the Seller’s residency status should never be treated as a formality. A Buyer and their lawyer must make reasonable inquiries about whether the Seller is a non-resident of Canada for tax purposes. If the issue is missed and the Seller is later determined to be a non-resident, the Buyer will face liability to the CRA to the extent of the withholding requirements described above.

For Sellers, the key point is to deal with Section 116 as early as possible. Waiting until a few days before the Completion Date can create delays, holdbacks, and frustration for all parties. Sellers who live outside Canada, have recently moved abroad, or are uncertain about their tax residency should obtain tax advice early in the transaction.

For Buyers, the Agreement of Purchase and Sale and closing documents should properly address the Seller’s residency status. If there is any concern that the Seller may be a non-resident, the Buyer’s lawyer will usually require appropriate declarations, undertakings, holdbacks, or confirmation that a Certificate of Compliance has been obtained.

Instead of the Buyer withholding funds it has become common practice for the Seller’s lawyer and the Buyer’s lawyer to negotiate a holdback agreement whereby the Seller’s lawyer will undertake to holdback in trust from the sale proceeds an amount sufficient to satisfy the Buyer’s Section 116 withholding obligation pending receipt of the Certificate of Compliance, and to remit therefrom any funds required by the CRA.

It is also important to remember that tax residency is not the same as citizenship. A Canadian citizen may be a non-resident for Section 116 tax purposes on a particular transaction, and a non-citizen may be resident in Canada depending on their circumstances. Section 116 can have a significant impact on closing, especially where the issue is identified late. Early legal and tax advice can help avoid unnecessary delays and protect both parties.

At Kormans LLP, we assist Buyers and Sellers in identifying closing risks early and ensuring that real estate transactions are completed with proper attention to legal, tax, and practical requirements. Connect with our team of lawyers for any of your specific needs at 905 270 6660, today.

Disclaimer: This article is for general information only and does not constitute legal or tax advice. Parties should obtain advice based on their specific circumstances.

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