This article is the second in a series discussing the tax and reporting burden facing non-residents vendors who dispose of Taxable Canadian Property (TCP). This installment considers the consequences of disposing of shares of a corporation that are TCP and Taxable Quebec Property (TQP).
As discussed in our TCP primer, a Canadian corporation has important compliance requirements on the redemption, cancellation, or acquisition of its shares that constitute TCP and TQP. These requirements include notification to the Canada Revenue Agency (CRA) and Revenu Quebec (RQ) as well as the remittance of withholding tax. If a clearance certificate is not obtained, multiple layers of withholding tax may apply on the same amount when the underlying TCP and TQP are shares.
Subsection 248(1) of the Income Tax Act (ITA) defines TCP. Shares of a corporation will meet the definition in the following circumstances:
- Shares of private corporations if, at any time in the last 60 months, more than 50 per cent of the fair market value (FMV) of the shares were derived directly or indirectly from Canadian real property
- Shares of public corporations, if at any time in the last 60 months, the taxpayer-owned at least 25 per cent of the shares of any class, and more than 50 per cent of the FMV of the shares were derived directly or indirectly from Canadian real property
Taxation of TCP and TQP share redemptions
Section 212 withholding tax under Part XIII of the ITA
To the extent the proceeds on the redemption, cancellation, or acquisition of a share exceed the paid-up capital (PUC) of that share, a deemed dividend may, subject to certain exceptions, result under subsection 84(3) of the ITA and/or section 506 of the Quebec Tax Act (QTA). If the vendor/shareholder is a non-resident of Canada, withholding tax under Part XIII of the ITA could apply to that deemed dividend and the purchaser/issuer corporation will be required to withhold tax of 25 per cent (subject to any applicable treaty reductions) on the amount. RQ does not levy a separate withholding tax on deemed dividends resulting from a redemption, cancellation, or acquisition of TQP shares.
Section 116 withholding tax under Part I of the ITA
A non-resident is required to notify the CRA prior to, or within 10 days of a disposition (including a redemption) of TCP assets or shares by filing the prescribed form[1] along with supporting documents and the payment of 25 per cent withholding tax (subject to reduction based on a tax treaty) on the gain realized upon disposition.
QTA withholding tax
The withholding tax rules in Quebec for dispositions of TQP operate similarly to the withholding tax rules under the ITA, requiring 12.875 per cent of the capital gain to be remitted to RQ.
On a disposition of a TQP that is also a TCP, withholding tax may apply thrice on the same proceeds: (i) withholding tax on deemed dividend under the ITA, (ii) withholding tax on the gain on disposition pursuant to section 116 of the ITA, and (iii) withholding tax on the gain pursuant to the QTA.
CRA’s views on double withholding tax obligations on redemption, cancellation, or acquisition of TCP shares
The CRA has issued a number of views with respect to double withholding tax obligations (both under Part I and under Part XIII of the ITA) on a redemption, cancellation, or acquisition of TCP shares.
(i) CRA View 9406027 – withholding tax where a non-resident obtains clearance certificate under subsection 116(2)
In this view, CRA commented on a situation where a Canadian corporation redeemed its TCP shares held by a non-resident, and the non-resident applied for a clearance certificate under subsection 116(2). The CRA stated that the certificate limit under subsection 116(2), being the expected purchase price reported to the CRA pre-redemption, is equal to the “proceeds of disposition” as defined in section 54, which does not include amounts that are deemed to be a dividend by subsections 84(2) or 84(3), resulting in a gain amount equal to the PUC less any ACB. This View therefore suggests that there should be no double taxation of the deemed dividend as the amount of deemed dividend is carved out when computing the proceeds of disposition, and pursuant to section 116 the withholding tax is calculated only on the capital gain. The non-resident is however required to submit documentation supporting that it has paid or credited the amount of Part XIII tax on any deemed dividend.
(ii) CRA View 2008-0301701E5 – withholding tax where no notification to the CRA
A Canadian corporation redeemed its TCP shares held by a non-resident and the non-resident failed to notify the CRA.
The CRA relied on its response provided at the 1984 Canadian Tax Foundation Revenue Canada Round Table where it stated that the liability of the purchaser under subsection 116(5) is not affected by the fact that a portion of the proceeds may be deemed to be a dividend pursuant to section 212.1 (or any other provision of the ITA), since it is computed with reference to the cost to the purchaser of the property so acquired. Therefore, the purchaser is required to withhold tax on the deemed dividend under Part XIII and again on the purchase price (not the gain due to failure to notify) pursuant to subsection 116(5) which, contrary to the previous view, results in double tax on the deemed dividend.
Note that while the CRA did not suggest a recourse, a non-resident could later file a Canadian tax return to report the actual gain – equal to the amount of any PUC less the ACB – and receive a refund of the overpaid tax.
(i) CRA View 2010-0387151E5 – withholding tax where clearance certificate applied for but not obtained
In this View, a Canadian corporation redeemed its TCP shares held by a non-resident and the non-resident applied for a clearance certificate but did not obtain it until after the redemption was complete.
Similar to CRA View 2008-0301701E5 discussed above, the CRA observed that a purchaser must withhold tax on a deemed dividend under Part XIII and then again on the total purchase price under subsection 116(5), given the clearance certificate was not obtained within the time limits specified under the ITA. The CRA directed the non-resident to contact the International Tax Services Office (TSO) to request relief from double taxation. However, the CRA noted that relief from double taxation is not guaranteed as there is no statutory guidance available in this situation.
Similar to the recourse suggested above, the taxpayer may choose to file a Canadian tax return to report the actual gain and obtain a refund of the overpaid tax.
How should the CRA Views be interpreted?
As illustrated in the CRA guidance, where non-residents fail to comply with their notification obligations, the CRA and RQ may apply multiple layers of withholding tax on the full redemption amount by calculating proceeds of disposition without adjusting for an amount that is allocated as a deemed dividend on redemption. Where taxpayers pay withholding tax twice (or thrice) on the same amount, they should file a Canadian and provincial tax return (where applicable) to report the actual gain and request a refund of the overpaid tax.
Furthermore, the withholding tax liability can be significantly higher if the compliance obligations are not fulfilled as the withholding tax obligation is then calculated based on the unadjusted proceeds amount rather than the expected or actual capital gain. Interest and penalties would only serve to increase the tax liability which is applied to the resident purchaser.
Compliance is key
The non-resident vendor should apply for a clearance certificate as soon as the transaction is proposed to ensure they receive the certificate within 10 days of the redemption, cancellation, or disposition of TCP/TQP shares taking place. Where the seller has filed for a clearance certificate but has not obtained it, they should contact the TSO and RQ as appropriate to request relief from double taxation. Non-residents should file a tax return to recover excess withholding tax paid to the CRA or RQ.
Canadian residents should make reasonable enquiries when they suspect a party to a transaction involving TCP/TQP may be a non-resident of Canada and take steps to ensure the non-resident has obtained a clearance certificate.
To the extent a clearance certificate is not obtained, a purchaser should withhold tax under Part XIII and again under section 116 to comply with its federal withholding tax obligations. Additionally, in the case of TQP shares, a purchaser should consider the provincial withholding tax obligations. It is critical for a purchaser to withhold the entire amount of tax from the proceeds as it may be challenging to recover amounts once the proceeds are released to the non-resident.
[1] Form T2062 or Form T2062A.
