What’s Your Tax Issue? – Taxable Quebec Property

The Tax Issue:

If I were to be a Canadian non-resident living in the Caribbean and I have rental property in Quebec, besides filing a federal tax return for Electing under Section 216, do I have to file anything for Quebec?

The Answer:

Part XIII of the Canadian Income Tax Act provides for a 25% withholding tax on rents paid to non-residents. As explained in an earlier post, an election under section 216 can be made whereby the non-resident pays tax under Part I, effectively replacing the 25% withholding tax with the normal income tax on rental income, net of expenses.

Quebec, which collects and administers its own income tax, does not levy withholding tax on rents paid to non-residents. Therefore, no Quebec tax return is required during the time you own the property and collect rents.

However, property situated in Quebec is considered to be “Taxable Quebec Property”, and is subject to withholding tax upon the sale of the property. Similar to the rules under section 116 of the Canadian law, the Quebec Taxation Act (Section 1097) provides for a 12.875% withholding tax on gains derived from property situated in Quebec. If a clearance certificate is not obtained (Form TP-1097), the 12.875% is levied on the full sale price.

In the year of sale, you will have to file both federal and Quebec income tax returns in order to report the sale and (possibly) recover a portion of the withholding tax.

The End Of The Irritants

If you are the executor of an estate with non-resident beneficiaries, life just got a bit simpler. The federal budget of 2010 contained amendments to the definition of “taxable Canadian property” that will eliminate the irritating requirement to file requests for clearance certificates.

Until now, any capital interest in a trust or estate resident in Canada fell under the definition of “taxable Canadian property”. As such, the CRA has always taken the position that any distribution of capital by an executor or trustee constitutes a “disposition” by the beneficiary of a capital interest in that trust or estate. Where the beneficiary is a non-resident of Canada,  section 116 of the Income Tax Act requires that a clearance certificate be obtained within 10 days of the disposition. I discussed section 116 certificates in a previous post.

Most of Canada’s tax treaties would generally serve to exempt the beneficiary from any Canadian tax, so the entire process was often just a formality and a pesky irritant to trustees, and especially to unsuspecting estate executors who simply wanted to make even a partial payment of capital to a beneficiary.

New rules that took effect in 2009 served to reduce the compliance burden by eliminating the need for a clearance certificate where the trustee or executor was certain that the beneficiary was protected by a Canadian tax treaty. However, this required work to make the determination of residency of the beneficiary, analyze the relevant treaty and determine whether the beneficiary was related to the estate, and if so, report the distribution to the CRA.

With the budget of 2010, the definition of “taxable Canadian property” has been amended, and trusts and estates no longer fall within the definition at all, unless they owned significant amounts of Canadian real estate at any time within the prior 60 months.

This change will eliminate a major compliance burden for estate executors. The new rules will also eliminate Canadian private corporations and partnerships from the definition of taxable Canadian property in the same fashion as above.

Some work will still be required to ensure that the assets of the estate or trust have not contained significant real estate, but other than that, these rules are a welcome relief to Canadian executors.

What’s Your Tax Issue?: Sale of Canadian Real Estate

The Tax Issue:

I own one third of a country home (located in Canada) together with my two siblings and I recently moved to the Bahamas. Do I have to pay tax in Canada on my share when the property is sold, since I have no tax to pay in the Bahamas?

The Answer:

First, when you leave Canada to become a non-resident, there are certain rules to consider. The big one is that you have a deemed disposition of all capital property at fair market value as of the date you left. I would seek professional advice in this regard.

But there are exceptions, one of which is real property located in Canada. The taxation of your share of the country home, therefore, is deferred until you actually sell it. At that point, it’s fully taxable in Canada regardless of where you live, because it falls into the category of  “Taxable Canadian Property”.

At the time of the sale, you will have to provide the CRA with information and withholding taxes will likely apply to your share of the proceeds under section 116 of the Income Tax Act. You will have to file a Canadian income tax return to report the disposition and the taxes withheld will go as a credit against the actual taxes payable on the tax return. This issue was discussed in an earlier post. Again, at this point, a tax professional should be able to guide you.

Non-Resident Investors In Canadian Real Estate

Maybe it’s the global warming thing, but Canada has suddenly become a very popular destination for non-residents (“NR”) investing in real estate. What are the tax rules for non-resident investors, and what investment vehicle should be used?

Non-Resident Investors

A NR investor is subject to withholding taxes under Part XIII of the Act. Generally, 25% of gross rents must be remitted to the CRA each month. An election under section 216 may be made. Under this election, the NR files a tax return and is eligible for the same deductions as Canadian residents including capital cost allowance. However, it does not entitle the NR to loss carryovers from prior years.

A survey of the tax rules would be advised prior to investing in Canadian real estate

A survey of the tax rules would be advised prior to investing in Canadian real estate

If form NR6 is filed, the NR undertakes to file a return within 6 months from the end of the year, and the tax withheld is reduced to 25% of the estimated income after deductions. Where no undertaking is filed, the tax withheld is 25% of the gross rent, but the deadline for filing a return is extended to 2 years.

Under certain circumstances a NR paying interest to another NR may also be subject to withholding taxes on the interest payments.

A NR corporation would be subject to further withholding requirements known as branch tax. This tax is intended to equal dividend withholding tax on profits repatriated out of Canada by the NR corporation. The branch tax rates are similar to withholding rates for dividends, subject to treaty reductions. NR corporations are also subject to tax on capital in certain provinces. Finally, an NR corporation may be subject to “thin capitalization” rules that restrict interest deductions.

A NR trust pays no branch tax or tax on capital. Losses of a trust , however, cannot be flowed out to beneficiaries.

Using a  Canadian Investment Vehicle

The two major choices for a Canadian investment vehicle is the Canadian resident trust or the Canadian corporation.

A Canadian corporation is subject to the full rates of tax on investment income. Unless it qualifies as a Canadian controlled private corporation, no part of the taxes payable will be refundable upon the payment of dividends. Dividend payments will be subject to withholding taxes of 25%, unless reduced by treaty. Further, in certain provinces, a Corporation is subject to tax on capital. Thin capitalization rules apply as well. These factors make this vehicle an unpopular choice for most NR investors.

A Canadian trust is not subject to tax on capital. Nor would the payments to beneficiaries of after-tax income be subject to any withholding taxes. Thus, the trust would be subject to tax only once, at the highest marginal tax rates for individuals. This rate could vary, depending on the province of residence of the trust.

Dispositions of Real Estate by Non-Residents

As taxable Canadian property, a gain on the disposition of real estate by a non-resident is generally subject to Canadian tax at Canadian rates for capital gains and recaptured capital cost allowance.

Withholding taxes must be remitted, and may be based on the gain on sale only where a withholding tax certificate is obtained under section 116 of the Act. If no certificate is requested by the due date (either before the sale, or within 10 days following the sale), then the purchaser is required to withhold based on the gross purchase price. The withholding rate is 25%. An additional 12% applies for the province of Quebec, which has its own certificate request procedure under Article 1097.

One common problem that arises when a NR disposes of Canadian real estate is that a 116 certificate will only be issued if all the withholding requirements have been met in the past. That is, if no returns were filed under section 216, then the CRA will require remittance of 25% of gross rents for the previous years plus interest. If the 2 year deadline has passed, the CRA will normally not accept late-filed 216 returns.