Case Notes For July, 2019

Kau v. The Queen, 2018 TCC 156, by Aasim Hirji

Section 116 of the Act provides rules that protect the Canadian government's ability to collect tax on capital gains on a disposition of "taxable Canadian property". "Taxable Canadian property" includes real property situated in Canada, Canadian resource-related property and the shares of corporations where the value is principally derived from Canadian real property or resource property.1 When a non-resident of Canada disposes of, for example, a residential property, a notification requirement is triggered, whereby the disposition has to be reported to the Canada Revenue Agency ("CRA") either before the disposition or within ten days after the disposition. If no notification is made to the CRA and a compliance certificate has not been issued, the purchaser is required to withhold 25% of the purchase price and must withhold on that amount at closing and remit that amount to the CRA within 30 days. In order to obtain a compliance certificate, the vendor must have notified the CRA and remitted 25% of the estimated capital gain.2

Subsection 116(5) assigns the tax liability to the purchaser, on behalf of the non-resident vendor, of 25% of the purchase price, unless, inter alia, after reasonably inquiry, the purchaser had no reason to believe that the non-resident person was not resident in Canada.

In Kau v. the Queen3, the Tax Court of Canada discussed what constitutes a "reasonable inquiry". The purchaser of an Ontario property (the "Taxpayer"), retained an Ontario lawyer to handle a real estate transaction for him. The vendor was also represented by a lawyer in Ontario. The Court noted that the Taxpayer knew the property was an investment property of the vendor, and that the Vendor did not live there. Furthermore, the vendor's address on the sale was located in California.

Prior to closing, the Taxpayer's sent to the vendors lawyer a standard requisition letter, specifying 26 requisitions required for purposes of closing the transactions, including satisfactory evidence of compliance with section 116 of the Income Tax Act. Shortly thereafter, the closing documents were revised to indicate they would be signed in California.

Shortly before closing, the Vendor signed a one sentence "unsworn statement", being titled an "affidavit" (though it was unsworn). The Vendor stated ""I am not a non-resident of Canada within the meaning of section 116 of the Income Tax Act (Canada) and nor will I be a non-resident of Canada at the time of closing."4

The Court noted that the Taxpayer himself did not make enquiry into the residency of the vendor, however, he did, "entirely reasonably", engage his solicitor to act in his best interest in efficiently bringing this real estate transaction to his successful conclusion (which includes compliance with section 116 of the Act). The Court then looked to determine whether the Taxpayer's lawyer had satisfied this obligation.

The Court looked to the fact that what the Taxpayer's lawyer did was the basic inquiry they would have expected in any event, pursuant to the Ontario Real Estate Association standard form language in clause 20. The Court went further to note that in this instance, the lawyers actions would have been "adequate" if there had not been "red flags signaling a potential that residency was outside Canada", and that the response received was insufficient (especially with an unsworn statement) to resolve those red flags in the absence of follow up questions. The Court noted that:

"It is obvious that "reasonable inquiry" entails consideration of not just what was asked, but also of response(s) received. Here, follow-up questions would have been appropriate.... The statutory provision involved, subsection 116(5)(a), calls for and deserves more than a brief, baldly stated affidavit or solemn declaration when there are factual red-flags potentially suggestive of non-residency. The matter should then be pursued, to give due effect to the fiscal concern that Parliament sought to address in its drafting of subsection 116(5)(a).

Ultimately, the Court found that the Taxpayer did not make a reasonable inquiry (as his lawyer did not), which resulted in the Taxpayer being liable for 25% of the purchase price.

Takeaways:

This case serves a cautionary tale to both home buyers and real estate lawyers. If any indicia of non-residency exists (such as an address outside Canada for the vendor), it is necessary to ask follow-up questions, rather than relying on a simple statement of residency. In...