Perhaps you’ve heard the story of the man who was in the hospital in a coma for several weeks. His wife was by his side the entire time. After waking up, his eyes filled with tears and he said to his wife: “Dear, you’ve been with me through so many bad times. When I broke my leg, you were by my side. When I lost my job last year, you were there. When our life savings disappeared, you stood by me. And as my health has failed, you’ve been here with me. You know what?” he said. “What is it honey?” his wife asked. “I think you’re bad luck,” he replied.
Bad luck can come in many forms, including nonsensical tax reassessments from Canada Revenue Agency. On July 31, a decision by the Tax Court of Canada upheld just such a reassessment. The judge’s decision makes little sense if you ask me, but it serves as a warning for the rest of us.
This is the case of Kau v. the Queen (2018 TCC 156). In June, 2011, Mr. Kau purchased a condo in Toronto from Mr. Y for $368,000. Mr. Y might have been a non-resident for Canadian tax purposes (he had a California address), although Mr. Y himself said that he was “not a non-resident.”
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Why does this matter? Well, Section 116 of our tax law will require a purchaser of Canadian real estate to withhold 25 per cent of the purchase price and send it to the taxman if buying the property from a non-resident person. This is meant to ensure that non-residents who own and then sell Canadian real estate pay their share of taxes on any capital gains.
Section 116 requires the buyer to make a “reasonable inquiry” and have “no reason to believe that the seller is a non-resident of Canada.” Without this reasonable inquiry and belief about the seller, the buyer is supposed to withhold 25 per cent of the purchase price and send it to the taxman.
In our story, Mr. Kau didn’t withhold 25 per cent when paying Mr. Y. You see, Mr. Kau’s lawyer did ask about Mr. Y’s residency status. The response received was a signed affidavit that read “I am not a non-resident of Canada within the meaning of Section 116 of the Income Tax Act (Canada) and nor will I be a non-resident of Canada at the time of closing.”
This “declaration” by the seller wasn’t good enough for the Tax Court judge, because it wasn’t a “solemn declaration” (which carries the weight of an oath). He concluded that Mr. Kau did not undertake “reasonable inquiry” and should have had reason to believe that Mr. Y was a non-resident.
The result? Mr. Kau lost his case, and must now fork over $92,000 (25 per cent of $368,000) to the CRA, representing the withholding tax that should have been deducted from the purchase price paid to Mr. Y.
So, the onus is now on the buyer of real estate to not only collect taxes on behalf of the CRA when a non-resident is selling a property, but to also make a judgment on when to investigate further the tax residency of the seller – as though a layperson is qualified to know when and how to make that inquiry.
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The judge suggested that Mr. Kau needed only to ask for a copy of the seller’s driver’s licence or could have simply asked what the permanent address of the seller was. The problem? These facts are not nearly sufficient to suggest a particular tax residency. There’s no level of inquiry a layperson could undertake to arrive at a reasonable conclusion about a seller’s tax residency; it’s too complex an issue.
There will always be a need to rely on a declaration of the seller. In this case, the “declaration” made by Mr. Y was not a “solemn declaration;” the “affidavit” was not a “sworn affidavit,” and so the judge concluded that Mr. Kau should have had reason to believe that Mr. Y was a non-resident.
So, if you’re thinking of buying a home, take heed. If you suspect the seller might be non-resident, obtain what’s called a clearance certificate from the seller, which is issued by the CRA and confirms that you don’t need to withhold any tax (good luck with this request if you’re in a seller’s market). Failing this, be sure the seller signs a “sworn affidavit” or makes a “solemn declaration” about their residency status – then hope that’s sufficient to get you off the withholding-tax hook should the CRA want to collect from you.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at firstname.lastname@example.org.