NEW RULES FOR DISPOSITIONS OF CANADIAN CORPORATIONS BY NON-RESIDENTS
The 2010 federal budget contained changes that will be of benefit to non-residents of Canada investing in Canadian companies and other entities. This change will reduce the compliance burden for non-resident vendors that are resident in countries which have a tax treaty with Canada that provides relief for gains on shares of Canadian corporations. For non-residents that reside in non-treaty countries or where a treaty does not provide specific relief for these gains, the change will also provide a tax saving.
Non-residents are subject to Canadian tax on dispositions of shares of corporations and certain other interests in Canadian businesses which fall into the definition of “taxable Canadian property”. Under the rules that applied before the budget, where the value of the company was not derived principally from real property, tax treaties between Canada and the vendor’s country of residence would, for many, exempt the gain from the sale of the shares from Canadian tax. However, even with the recent change to exempt tax withholdings for treaty-protected property, it was still necessary to file a form with the Canada Revenue Agency (CRA). And, many non-resident vendors could not take advantage of the change as they had to basically prove to the purchaser that the treaty exemption was available. In addition to showing that the property was eligible for treaty relief, the non-resident had to prove to the purchaser’s satisfaction that they were eligible for treaty relief in general. This often made the change problematic to apply in arm’s length transactions. Where the treaty-protected property exemption could not be used, it was necessary for non-resident vendors to obtain a “clearance certificate” from the CRA so that the proceeds from the sale would not be subject to withholding tax. This can be an expensive and time consuming process.
The proposed rules released in the 2010 federal budget will help resolve these issues. With the budget changes, the definition of “taxable Canadian property” under Canadian domestic tax law will be amended to exclude shares of corporations (and other interests) that do not derive their value principally (generally more than 50%) from real or immovable property situated in Canada, Canadian resource property or timber resource property, at the time of sale and during the previous 60 months under a look back rule. This change will apply in determining whether a property is a taxable Canadian property after March 4, 2010.
In addition to share transactions, these changes will also benefit trust administrators. As long as less than 50% of the value of a trust or estate is derived from real or immovable property situated in Canada, Canadian resource property or timber resource property, at the time of sale and during the previous 60 months, there will be no need to obtain clearance certificates for trust distributions to non-resident beneficiaries, either because treaty protection was not available or because the trustee was not willing to rely on a non-resident’s assertions that a treaty exemption was available.
Although the change is very good news, there are some issues that may arise. First, there will be situations where valuation issues may exist or there may be a lack of information. That is, it may be difficult to determine with certainty whether the 50% test has been met at the time of sale and during the last 60 months. Without absolute certainty, purchasers may still require the vendor to go through the clearance process so that they are relieved of any potential withholding requirement. In this regard, it is unfortunate that a “due diligence” exception for purchasers who make reasonable inquiries was not included in the draft rules. Such a rule would relieve a diligent purchaser of the requirement to withhold if they make reasonable inquiries, shifting responsibility to the vendor to make a final determination of whether the property is taxable Canadian property.
A second problem is the look back rule. Some of Canada’s trading partners have rules similar to those introduced in the budget, but focus on the value of the property at the time of sale. In some cases, the corporation or trust may have had real estate (or other immoveable property) in the past, and disposed of that property in a taxable transaction during the 60 month period before the entity is disposed of. Under the draft rules, the policy of treating these interests as taxable Canadian property is questionable as the underlying immoveable property was already taxed.
Although there are a couple of issues to consider with the budget changes, from an overall perspective they will help make investing in Canada by non-residents more attractive and will also relieve compliance issues for existing shareholders and trust beneficiaries. For more information on these changes, contact your BDO advisor.
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