| Canadian Real Estate |
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Non-Resident Ownership of Canadian Real Estate
There generally is no restriction on the ownership of Canadian Real Estate by persons who are not residents of Canada. The Canadian tax system, however, may trap some people and be costly for those who are not familiar with it, or assume it operates the same as the US tax system.
Unlike the United States, Canada does not have an Estate or Gift tax. It does, however, deem any such transfer, as well as a number of other transactions, to be deemed a sale of the property at its fair market value, with a resulting capital gains tax being due. Is a similar vein, a change of use of the property, say from rental to personal residence, is also deemed to be sale of the property. These rules apply to both residents and non-residents of Canada. The deemed sale provision, however pose problems for the US owner as the transaction is taxed currently in Canada, and later in the US when the property is ultimately sold, potentially resulting in double taxation from expiring foreign tax credits.
Rental Income
Any net rental income from a Canadian property is currently taxable to a Canadian resident and to the US owner. In the case of a non-resident owner, the law requires the Canadian agent to withhold 25% of the gross rents and remit them to the government. The non-resident owner can make an annual filing with the government, declaring the net rental income from the property, and if approved, the required withholding will be 25% of the net rental income. One of the conditions for the reduced withholding is the owner’s agreement to file a Canadian tax return to report the net rental income. If the non-resident owner is not subject to the reduced withholding, he still may file the appropriate Canadian tax return, and be refunded the excess withholding. If he does not file the tax return, the tax obligation will be satisfied by the 25% withholding on the gross income. On the US side, the actual Canadian taxes paid are available for the foreign tax credit, or alternatively, for the deduction for foreign income taxes paid.
Sale of Property
The agent changing title to Canadian Real Property will require the transferor to certify his Canadian resident or non-resident status. The agent is required to withhold 25% of the sales price (or fair market value in the case of non-sale transfers). This creates an obvious cash-flow problem, and sometimes an impossible situation if the property is over 75% mortgaged. As with rental income, the transferor can submit documentation to the government to report his net gain or loss on the property, and if approved, the withholding will be 25% of the net gain. If the approval is not received before the transfer closes, the agent will retain the 25% of sales price in his escrow account, and will only disburse to the government and the transferor when notification is received from the government. Again, as with rental income, the condition for the reduced withholding is the filing of a Canadian income tax return to report the transfer.
Compliance
The form requesting the reduced withholding on the transfer asks if the property has been rented. If the property has not been rented, the filing of the tax return to report the sale should complete the tax involvement with Canada, subject to normal audit exposure. If, however, the property had been rented, my experience is that the transaction will be reviewed by the government, and if all of the rules related to rental income as discussed above were not followed, additional amounts will be required to be withheld. This process may delay approval for the reduced withholding.
If tax returns were not filed and taxes were not withheld from the rents, the government will demand 25% of the gross rental income. For the immediate proceeding two years, the period in which a non-resident may file a tax return to claim taxes on net rental income, tax returns may be filed and the 25% of tax paid on net rental income. If tax returns were filed but taxes not withheld, interest will be charged on the withholding that should have been made from their due date to the filing of the tax return.
Strategy
The income taxes due on the sale of Canadian property by a non-resident of Canada is a two step process—the withholding of tax on the sale, and the determination of tax by the filing of tax returns. Arguing the withholding will only delay the closing on the sale—that is not the determination of tax. The filing of the tax return to reflect the reality of the transaction is the time to have any dispute with the Canadian Government. The issues of non-compliance with withholding and filing for rental income are areas of prime exposure and one where the government is very unforgiving.