Non-Resident Vendors: The Need for Changes to s.116 of the ITA

Recently I was asked to write an article for the Lawyers Weekly (a national newspaper in Canada directed to lawyers), this is a re-post of that article originally published by the Lawyer’s Weekly October 8, 2010:

When we speak to law reform, real estate is generally a tortoise among hares and for good reason. Given that, for a majority of the population their home is their single biggest investment, there is a strong demand for a system that is efficient, fair and predictable.

However, for real estate lawyers in the current economic climate we are now dealing with the inability of Vendors to clear title in increasingly greater numbers. Unfortunately, the bureaucracy involved with Section 116 of the federal Income Tax Act adding to the uncertainty by delaying and jeopardizing sales of residential real estate. The eight month delays caused by procedural meandering, which has been readily acknowledged by the civil servants of the International Audit Division, gives purchasers in this buyers real estate market the opportunity to simply “walk” away from contracts with non-resident Vendors who are unable to clear title due to the requirement of a Section 116 holdback.

Section 116 requires a purchaser of residential real estate to withhold between 25% and 50% of the purchase price subject to a vendor obtaining a certificate of compliance from the Canada Revenue Agency (CRA). In the normal course of residential real estate transactions, this is accomplished by way of solicitor’s undertakings between the parties. In the past, these undertakings did not present a hurdle to non-resident vendors as the growth in the value of the property allowed the vendor to close, payout their lender, and simply wait to receive the holdback funds upon issuance of the certificate of compliance by CRA.

The current economic climate has dramatically changed this reality for non-resident vendors. Many non-resident vendors are required to payout high loan to value ratio mortgages and other sources of funds are no longer readily available. In the Okanagan Valley, where a large number of non-residents own secondary residences in our resort communities, this pressure has been compounded by the recent changes to the financing rules, which now require a minimum 80% loan to value ratio for secondary residences, and in turn this has decreased the pool of eligible buyers for any given property.

Often, with desperate sellers and fickle buyers, the real estate agents must cobble these deals together down to the last penny and leaving little if any additional funds for the holdback on the closing date. The nature of residential real estate practice (at least in British Columbia) is that the contract is often firm and binding on the non-resident vendor when the vendor is informed by their lawyer of the holdback amount thereby putting the vendors in a position where they are unable to close. In Epp v. Yung (1993), 35 R.P.R. (2d) 1 (B.C.S.C.) the court held that, even if the vendor disagrees with the amount of the holdback, the vendor must still close without access to the holdback funds and provide title free and clear of all financial encumbrance.

In 2008, CRA introduced changes to the s.116 certificate of compliance requirements; however these changes have not adequately addressed the issue. CRA personnel have acknowledged the delays and have recently provided advice to the Institute of Chartered Accountants, as published by their member advisory in September 2009, on the steps a vendor can take to minimize the time it takes to obtain a certificate of compliance. These steps include: a) ensuring forms are submitted early (ideally well in advance of closing); b) ensuring the vendor is registered for a tax number; c) ensuring that all the supporting documentation is available (eg; form T2062) to allow CRA to determine the adjusted cost base as well as the proceeds of disposition; and d) ensuring the cover letter requests a “Certificate of Compliance” (as opposed to a clearance certificate which causes confusion with another CRA program). CRA has been reported to be piloting a regional intake centre to quickly deal with “low risk files”, however there have been no reports on this program’s success or if it will be expanding.

The fundamental problem with the process for obtaining Certificate of Compliance is not a lack of manpower, however it is the associated purchaser’s requirement to withhold and investigate the nature of the vendor’s tax liability that, in the context of residential real estate needs to be statutorily changed. The objectives of the Income Tax Act would be much better served if, subject to receipt of a vendor’s statutory declaration of no gain, the liability for the vendor’s taxes remained with vendor and the CRA would cease to rely on purchasers as indemnitors.

This call for reform is not new and the need for change to the section 116 procedure has been noted by the Advisory Panel on Canada’s System for International Taxation in December 2008, wherein they recommended that the government “eliminate withholding tax requirements related to the disposition of taxable Canadian property where the non-resident certifies that the gain is exempt from Canadian tax because of a tax treaty”.

Absent a fundamental change in the legislation, the current requirements set out in section procedure are inefficient and have created instability in the residential real estate market, at a time when greater stability is needed. Since most residential contracts of purchase and sale are entered into without legal advice and lawyer s are often only engaged a short time prior to closing, it is often too late for legal counsel to complete the step necessary to get the transaction back on track for a timely closing. The end result is that this statutory requirement is doing more harm than good in our current real estate market.

The Story of a Collapsing Deal

(based on real life events)

At the end of August 2010, Dave and Jane were buying their first home. Nervous about finding the “right” home for themselves and their two kids they look at property after property. Finally, at the beginning of August 2010, the house at 3245 McLeod Road came up for $375,000. It was the right price, close the schools, and close to Dave’s work at the Gorman Mill. The Seller, John, had been anxious to sell for a long time, and needed to simply walk away from the home, his credit union mortgage was $355,000 and he needed a fresh start in a new town. Both parties were anxious to see the deal get done.

They came into see Peter, their real estate lawyer on August 22, 2010 and at that meeting they signed all the documents. He explained the process to them, including if the “what ifs” happen, and how the court process worked. Although there was only a very small chance these bad things would happen he wanted them to be armed with knowledge.

Dave and Jane were very excited and they booked their moving truck for September 1, 2010 (their Possession Date) and they have picked out paint colors for their daughter’s new bedroom and began to plan their lives in their new home.

On August 31, a series of unfortunate events occurred. First, the Land Title Office (which is electronic) went “offline” and no land title transfers were permitted to be registered at the end of the month. Closing was delayed, but not to worry the contract had been drafted to allow for this hiccup.

Then, on September 1, with the moving truck in the driveway, the Vendor’s lawyer “discovered” that they had an “IRD” penalty (of $21,000) on their mortgage and now the Vendor (John) did not have enough money to “payout” the mortgage on title. The Vendor (John) could not complete and could not fulfill the promise he made to give the “title free and clear of all encumbrances”. Dave and Jane had already moved out of their rental house and they were now homeless, forced to live in a motel. The moving company (for a small ransom) placed all their belongings in storage.

Crestfallen, Dave and Jane came to see Peter and Eric (a real estate litigator in the same firm) to ask what to do, they had remembered that part of their prior meeting dealing with the “what ifs” in real estate. The two lawyers explained that Dave and Jane could sue for damages or specific performance to get their dream home and they immediately started to put pressure on the Vendor to complete by “tendering” a “ready, willing and able to complete” letter, placing a caveat on the property title, and commencing legal proceedings.

Within 3 weeks there was a very happy ending, the Vendor was able to negotiate with the bank, and to avoid a lawsuit paid the additional costs (including legal fees) for Dave and Jane.

The moral of this story: For buyers, hope for the best, be prepared for the worst. For Realtors, ensure your sellers can clear title prior to signing the deal, or, at least, place a “subject to the seller ensuring they can clear title” so that you have pointed out the issue to them.

Non-Resident Sales

When a non-resident of Canada is the Seller of real property special considerations apply to ensure that the government of Canada is paid all applicable taxes on sale.

s.116 Income Tax Act – provides that the BUYER must withhold between 25-50% [depending on the nature of the property] of the Purchase Price from the Seller until the Seller provides the Buyer with evidence that they have obtained a s.116 clearance certificate from the Canada Revenue Agency.

Currently these certificates are taking up to 8 months to process, therefore, Vendors are advised to apply early, and ensure that they can clear financial charges from title without the entire purchase price prior to entering into a binding contract