In British Columbia, the provincial government has imposed 15% property transfer tax on foreign real estate buyers in Metro Vancouver. Local government strongly believe that “this tax would limit demand, making housing more affordable in Metro Vancouver.”

While in Ontario, there are a lot of discussions on whether Toronto should follow the similar steps to cool down foreign investment in the city. We don’t expect the debate will stop. The real question is that whether it is straight-forward for foreign investors to invest in Canadian real estate market?

For a lot of foreign real estate buyers, the intent to purchase a property in Canada can be as follows:

• for personal use,
• or for diversifying/expanding investment portfolio,
• or for speculation

No matter what the intent is, the tax implication needs to be understood thoroughly before a decision is made.

First, who are “foreign buyers”?

Foreign real estate buyers can be individuals or corporations, even some other business forms. We are going to focus on “individual buyers” only here.  The reason why we have to define the “foreign buyers” at the beginning is just because, as a non-resident of Canada, you pay tax on income you receive from sources in Canada. And the Canadian tax treatment for non-residents is significantly different from how it applies on Canadian residents.

So, who are foreign buyers then?

Normally, foreign buyers are not closely connected with Canada in terms of social ties and stay less than 183 days during the year.  Based on the criteria to determine the resident status for tax purpose, foreign buyers are individuals either:

• have no significant residential ties in Canada and lived outside Canada throughout the year, except if they were a deemed resident of Canada.
• Or did not have significant residential ties in Canada and they stayed in Canada for less than 183 days in the year. Any day or part of a day spent in Canada counts as a day.
• Or were deemed not to be resident in Canada under the Income Tax Act because of the provisions of a tax treaty Canada has with another country.

You may be curious about what “residential ties” are about. Generally speaking, residential ties include:

• a home in Canada;
• a spouse or common-law partners in Canada; and
• dependants in Canada;
• personal property in Canada, such as a car or furniture;
• social ties in Canada, such as memberships in Canadian recreational or religious organizations;
• economic ties in Canada, such as Canadian bank accounts or credit cards;
• a Canadian driver’s license;
• a Canadian passport; and
• health insurance with a Canadian province or territory.

Determining the residence status for tax purpose requires considering all of the relevant facts, including

• residential ties with Canada (whether it is significant /secondary)
• and length of time, object, intent,
• and continuity with respect to stays in Canada and abroad.

What risks are non-resident buyers exposed to?

Non-resident buyers are exposed to more risks than what local investors face. Various risks can potentially eat up the return from the acquired property. Before investing in real estate in a foreign country, understanding the pros and cons of such a venture is always good idea.

Here are some common risk exposures that non-residents may consider when buying properties in Canada:

• Foreign currency/Canadian dollars fluctuation
• Access to financing in Canada
• Canadian local economic environment and regulation
• Canadian tax obligation
• Risks associated with property management
• Exit/liquidity risk

What costs are associated with the purchase and later on?

Never underestimate the costs associated with the purchase of real estate property. Here is the list but not exhaustive:

• Legal fees paid to lawyers for the review of purchase agreement, likely in the range of $1,000, one time only
• Agent’s commission paid to agents representing the buyer, approximately 5% of the property’s market price, one time only
• Property Transfer Tax levied by local provincial/municipal taxation authorities. It is part of transactions costs paid by buyers. One time only
• Home inspection fee paid to examine the property’s conditions, usually in the range of $500, one time only
• Property insurance paid to cover the risks associated with the property, likely in the range of $700 for a regular residential property, insurance premium recurring every year
• Property tax charged annually by local township/municipality to support local education system/infrastructure/administration, usually in the range of 1% of the assessed value of the property
• Condominium fees charged monthly by the condominium corporation to cover building insurance and major maintenance , usually monthly $300 for a new condominium unit in 400 square fee
• Agent’s fee paid to manage the rental property on behalf of the owners, find tenants and pay expenses
• Accountant’s fee paid to file tax returns/request clearing certificate if there is a disposition of  the property or the property is rented out, usually in the range of $1,000 depending on the complexity of the transaction

What type of ownership structure is available for non-residents in Canada?

There are various ownership structures available for non-residents to consider:

• Directly own real estate property

For commercial real property, it may not be good idea that individuals directly own it as exposed to civil liability. As compared, it is common that non-residents own residential property under his/her name. In addition, if the property is rented out, the gross rental revenue collected from Canadian tenants would be subject to a 25% withholding tax. However, non-resident investors have an option to elect to submit the income tax (if any) on the net rental income basis. The disadvantage to non-residents is Principal Resident Exemption is not available when the real property is sold.

• Own real estate property through a trust

Trusts would be subject to the same Canadian tax rules to real property owned by a Canadian resident, assuming trusts are residing in Canada. What about non-resident trusts? Similar to the non-resident owning real property, the non-resident trust needs to pay 25% on the gross rental income unless an election is made. Owning real estate property through a trust may get more complicated then you expect. It is strongly recommend you consult with your lawyer as well as accountant.

• Own real estate property by a corporation

Simply put, the rental income generated in the corporation would be subject to Canadian federal and provincial income tax. There are some withholding tax restrictions on dividend distributed to non-resident shareholders.

• Own real estate property by a Canadian partnership

Canadian partnership is considered as a flow-through entity as its net income (for income tax purpose) would be distributed to the partners of the partnership based on the partnership agreement. Partners can be individuals or corporations.

What if a non-resident likes to hold for personal use?

After the purchase, non-residents prefer to hold the property for personal use. There is little tax impact until the property is sold/rented out. One reminder for non-residents is to maintain a healthy cash flow is critical as various costs kick in once the ownership is possessed by the buyer.

What about selling the property?

So, the timing is good and the non-resident is interested in selling the property. Then what’s the tax impact?

First of all, the process is not straight-forward and it may cause cash flow issues to non-residents.

Let’s look at the details.

Before the transaction is completed, the seller (a non-resident) is required to provide a Section 116 Certificate to the buyer so that buyer’s withholding obligation can be eliminated. Otherwise,the buyer is obligated to withhold and remit to the CRA  25% of the gross sale proceeds. Read carefully, it is GROSS not net amount. By this way, non-resident sellers need to put up considerable cash flow up-front before the transaction is completed.

A non-resident can apply to the CRA for Form T2062A, “Request by a Non-Resident of Canada for a Certificate of Compliance” .This form requires the non-resident to state the name and address of the buyer, the date of the transaction, a description of the property and the expected gain and recapture if any from the transaction. The request may be filed ahead of the transaction or no later than ten days after the transaction is completed. In reality, this may put non-resident sellers in an unfavorable position as the Certificate may be taken too long to obtain from the CRA.

Before the CRA issues a certificate of compliance, the non-resident vendor is required to make payment or post security on account of tax. The amount of payment/security for capital gains is equal to 25% of the capital gain. The amount of payment/security for recaptured CCA is computed at the non-resident federal tax rates applied to the amount of recapture. Failure to comply with section 116 may result in a penalty pursuant to subsection 162(7) plus any applicable interest, and/or imprisonment.

A Part I return must be filed for the year of disposition to report the amount of the actual capital gain from the disposition. Some non-residents may also have to file a subsection 216(1) return to report the amount of CCA recapture from the disposition and any rental income earned from the property during the year.

Filing a tax return for non-residents is never being easy.

What if a non-resident likes to rent it out?

Non-resident may consider renting out the property In order to maintain a break-even cash flow. What’s the tax impact on a rental property then?

As a non-resident of Canada, he/she can appoint a Canadian agent to submit 25% of the gross rental income withheld to the Canada Revenue Agency (“CRA”) within 15 days of each month-end. In addition, by March 31^st of each calendar year, he/she also needs to file the summary of total gross rent and taxes withheld to the CRA ON form NR4, “Statement of Amounts Paid or Credited to Non-residents of Canada”.

In his/her home country, a non-resident will declare the rental income to the local tax authorities and use the tax withheld as a foreign tax credit on the local tax return. Back to Canada, what if tax is not properly withheld? The CRA will have no hesitation to impose interest from the date of each rent payment, plus a 10% penalty. What a burden!

Here is a solution to reduce withholding tax burden:

Step 1: At the end of the prior year, file Form NR6, which provides an estimate of net rental income but excluding depreciation and other non-cash expenses;

Step 2: Before March 31^st of each calendar year, file Form NR4, which is to report the amount of taxes withheld by the non-resident for the calendar year;

Step 3: Within the first  6 months of the calendar year, file Section 216 return, which to report the actual rental income earned in Canada deducted by the expenses like property taxes, repairs and maintenance, interest on debt used to purchase the property, condominium fees, property management fees, etc.

There may be a refund position between the withholding tax remitted Form NR4 and the amount of income tax liability filed in Section 216.  Overall, going through those filing steps will help a non-resident improve cash flow in the long run.

Don’t forget about GST implication.

What’s the GST then? The Goods and Service Tax (federal) (“GST”) is considered sales tax.  Most provinces in Canada have their own sales tax, which has been harmonized with the GST in Ontario, British-Columbia, Nova-Scotia and New-Brunswick for at global rate of 13%.

If the property is residential, no GST is payable on the rental income. In this case, you may choose not to register for GST, when the total rental income (GST taxable) is less than $30,000 during a year;. The tenant will not be required to pay GST on the property and the non-resident will not be required to file GST returns, remit GST, etc.

For commercial property, GST registration may be required.This will likely more preferable as GST input tax credit is allowed to reduce GST collected.

What if a non-resident purchased/rent out the property and then become a resident later on?

In some cases, clients purchased properties when they are still non-residents, then later on settled down as residents. So, the question is what’s the tax implication then?

There are multiple aspects of this scenario.

Firstly, as a non-resident, he or she investing in real estate property in Canada is liable to pay tax on gains resulting from the disposition of that property. The important thing is non-residents are not generally eligible for the Principal Residence Exemption. As compared, Canadian residents enjoy the favourable tax treatment as they are entitled to such exemption.  Residents pay no tax on that gain on the disposition of the principal residence.

Secondly, on a calendar year, an individual’s tax status needs to be determined, either non-resident or resident.

Thirdly, rental income over the respective periods between being non-resident and being a resident needs to be filed differently.

In our case, the client spent around less than 5 months in Canada in 2015 and bought a property during the stay and rent it out later of the year. In 2016, the client’s immigration case has been approved and came back to Canada and stay till now.

Let’s break it down the periods.

In 2015, the client was a non-resident for Canada as he stayed less than 183 days in Canada and had no social ties. 25% of the rental income on the investment property needs to be withheld and remitted monthly to the CRA. As NR6 is not ready to file in late 2015 as the client came back as a permanent resident in early 2016. He needs to pay tax on the gross rental income.

In 2016, the client becomes a resident of Canada. He needs to file T1. Rental income and expenses are required to report on T1.

If the client would like to sell the property before 2016 when he becomes a resident for Canada, the client will be liable to pay tax on the gain from the disposition. No Principle Residence Exemption is available for him. The detailed procedures are discussed in the section “What about selling the property?” above.

However, if the client sells the property after becoming a resident, he is eligible for the Principle Residence Exemption and sheds the gain attributed from the time when becoming a resident.  As a result, a portion of the gain will be exempt from capital gains tax.

What about flipping?

This is a very interesting question that a client recently raised.

In some cities in Canada, the return is quite attractive when fixing the old property and reselling it for a profit. This is what we call “property flipping”. In some cases, investors refer buying low and selling high as flipping as well.

As the real estate market in Canada continues grow, the CRA has noticed the incompliance issues and gradually taken action in addressing them. Property flipping is one of the 5 main areas of concern that the CRA targets. You can refer to the details here.

In our client’s case, Mr. John Doe buys a residential property, renovates it inside-out as Mr. Doe has extensive experiences in this area, and plans to sell it for a profit. Other than the tax implication in selling the property (capital gain/business income), what else should cause concern for a non-resident? Here is the answer:

There may be a GST implication in selling this substantially-renovated property. This means if a residential property has gone through renovation works like structural changes, GST may arise on sale as the property is being treated as “new residential premises”. And the non-resident is obligated to remit the GST collected to the CRA.

 What about gifting to other Canadian residents?

In case a non-resident likes to gift the real estate property to other Canadian resident. There are important income tax rules of which a non-resident should pay attention to.

First of all, relax; there is NO “gift tax” in Canada.

When a non-resident gifts a property, he or she will be deemed to have sold the property for fair market value, which is an estimate of the price can be sold in the market at that time. As a result, capital gain or loss resulting from the transaction will be calculated. And the non-resident is liable for the tax on the capital gain (only 50% included) if the fair market value is more than what it has been paid for.

On the other side of the transaction, the individual (assuming an adult resident for Canada) who receives the gift is deemed to acquire the property at fair market value even there is no money involved. The important thing to remember is when the individual sells the property later on, the fair market value at the time he or she receives become the Adjusted Cost Base of the property.

How to file a non-resident tax return?

A non-resident should file the tax return depending on the type of Canadian income received during the tax year. Generally speaking, there are only two types of income associated with real estate property: capital gain and rental income.

So, if you receive capital gains during the year when the property is disposed, you should use the Income Tax and Benefit Package for Non-Residents and Deemed Residents of Canada.

And, if you receive rental income from a real property, please use the return called “Electing under section 216 of the Income Tax Act.” This allows you to pay tax on your net Canadian-source rental income instead of on the gross amount. If the non-resident tax withheld on this income is more than the amount that has been remitted under section 216, the excess will be refunded.

Generally, the non-resident tax return has to be filed on or before April 30 of the year after the tax year.

If there is a balance of tax owing, it must be paid on or before April 30 of the year after the tax year, regardless of the due date of the tax return.

Forms to be used

• Form T2062A  “Request by a Non-Resident of Canada for a Certificate of Compliance”
• Form NR6
• Form NR4
• Section 216 return
• 5013-R T1 General 2015 – Income Tax and Benefit Return for Non-Residents and Deemed Residents of Canada

Conclusion:

After going through various scenarios that non-residents purchase real estate properties in Canada, you may say “there is no way to get away from taxes in Canada.” Given that the filing obligation and tax and various costs associated with the property, the investment return may not seem that attractive unless the upside potential is huge and certain.

And remember careful tax due diligence/tax planning, based on non-resident’s particular situations, becomes critical in decision-making process.