International Tax: Recent Changes to « taxable Canadian property » Regime for Purchasers and Non-resident Vendors of TCP

1 juillet 2010

( Disponible en anglais seulement )

Changes introduced by the 2010 Federal Budget will impact the obligations imposed on non-resident vendors of “taxable Canadian property” (“TCP”), such as real property situated in Canada and shares of Canadian private and public corporations, and purchasers of such properties under the Income Tax Act (Canada) (the “Act”). More specifically, to encourage foreign investment in Canada, the Budget proposes changes to the TCP definition that will provide relief from: (i) obtaining compliance certificates and filing Canadian tax returns if non-resident vendors dispose of certain shares of corporations and interests in partnerships or trusts; (ii) imposition of Canadian tax on any gains realized by non-resident vendors thereon; and (iii) Canadian withholding tax obligations of purchasers of such properties for dispositions that occur after March 4, 2010.

Canada taxes non-resident vendors on gains realized on the disposition of TCP.  Capital gains on the disposition of shares and interests in partnerships or trusts are generally exempt from Canadian taxation under most of Canada’s tax treaties provided that the value of such properties is not derived principally (more than 50%) from real property situated in Canada.  The rules in section 116 of the Act apply to the disposition of TCP (other than excluded property). Section 116 of the Act was amended in 2008 to provide relief for dispositions of TCP that occur after 2008 if the TCP is “treaty-protected property”.  In practice, these new measures generally provide relief only in the context of non-arm’s length transactions.

Under the current TCP regime, purchasers and non-resident vendors of TCP must still comply with the requirements of section 116 even if an exemption under a tax treaty applies. Generally, the rules oblige a purchaser of TCP to withhold and remit a portion of the gross proceeds of disposition on account of the non-resident vendor’s potential Canadian tax liability, unless the Canada Revenue Agency (“CRA”) issues a compliance certificate providing a certificate limit at least equal to the purchase price.  In addition to obtaining a compliance certificate, non-resident vendors are also generally required to file a Canadian tax return for the year in which the non-resident disposes of the TCP.

With the changes proposed in the Budget, shares of corporations and interests in partnerships or trusts will no longer fall within the TCP definition provided that not more than 50% of the fair market value of such shares or interests is derived, directly or indirectly, from Canadian real or immovable property, resource or timber property (or options or interests therein) at any time during the 60-month period ending on the date of disposition.  The effect of these changes is to align the TCP regime with the provisions of Canada’s tax treaties.  This step is the latest in a series of measures that the Government has introduced to reduce the hurdles for non-residents investing in Canada.

From a Canadian tax compliance perspective, the narrower definition of TCP provides relief from the section 116 requirements that delay many transactions. Under the current TCP definition, non-resident investors who are exempt from Canadian taxation as a result of bilateral tax treaties would still be subject to section 116 and Canadian tax return filing requirements. The changes to the TCP regime will eliminate such Canadian compliance burden in many instances.

For Canadian taxation purposes, the changes introduce tax relief on capital gains previously only available under Canada’s tax treaties into Canada’s domestic law.  Now, non-residents of both treaty and non-treaty countries will receive equal tax treatment on gains realized on the disposition of certain shares and interests in partnerships or trusts.  This lowers the barriers to investing in Canada for many non-residents and diminishes tax treaty preferences for certain inbound structures.

The changes are of particular interest to:

  • Residents of countries that do not have a tax treaty with Canada
  • Residents of countries, such as Australia and Japan, whose tax treaty with Canada does not provide an exemption from Canadian taxation in respect of capital gains realized on disposition of TCP that do not derive their value principally from Canadian real property
  • US resident who are denied treaty benefits under the anti-hybrid rules and limitation on benefits provision of the Canada-US Tax Treaty

While the changes to the TCP definition have not yet been enacted, the CRA has indicated that it will be administering section 116 based on the new TCP definition effective as of March 5, 2010.  However, until the new TCP definition becomes law, purchasers of TCP may still request non-resident vendors to obtain and deliver a compliance certificate to protect themselves against potential Canadian withholding tax liabilities should the proposed changes not be enacted.  This will generally be more a concern for arm’s length purchasers.

The Venture Capital community, which has long been critical of the TCP regime, has welcomed these changes which will provide both Canadian compliance and taxation relief.  Historically, the TCP regime has been perceived by many as a barrier to investment in Canada. The relief provided by the proposed changes to the TCP regime will be relevant to many purchasers and non-resident vendors of TCP involved in Canadian transactions.

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