Canada: For Tax Purposes, Do You Know Where You Live?
In tax law, the concept of residency is used to determine tax liability based on whether there is a sufficient connection between an individual or legally recognized entity and a jurisdiction such that the jurisdiction is justified in taxing such individual or legally recognized entity on their worldwide income. Generally, taxpayers who are Canadian residents are taxed on all worldwide income while taxpayers who are not Canadian residents are generally only taxed on income tied to Canadian sources.
When non-residents of Canada sell Canadian assets, they or their advisors must determine whether such sale gives rise to a tax liability in Canada. Canada has the right to tax non-resident vendors on gains from the disposition of certain “taxable Canadian property” (“TCP”), except where the non-resident vendor is entitled to a treaty exemption. In broad terms, TCP includes Canadian real estate; assets used in a business in Canada; shares of a private company or interests in a trust or partnership that derive more than 50% of their fair market value from Canadian real estate, certain resource properties or interests or options for such property at any time in the past 5 years; and shares of a public company or mutual fund if, at any time during the past 5 years, 25% or more of the issued shares or trust units are owned by the taxpayer together with non-arm’s length persons and more than 50% of the fair market value of the shares or trust units derive from Canadian real estate, certain resource properties or interests or options for such property.
Section 116 Certificates
If a tax liability arises on the disposition of TCP by a non-resident vendor, such non-resident vendor is required to notify the Canada Revenue Agency (the “CRA”) about the disposition either before the disposition of the property or within 10 days after the disposition. The CRA will issue a certificate of compliance if it has received either an amount sufficient to cover the tax on any gain the non-resident vendor may realize upon the disposition of property or appropriate security for the tax. A certificate of compliance is often referred to as a section 116 certificate (a “Section 116 Certificate”), which is a reference to the governing provision of Canada’s Income Tax Act (the “Act”). If a purchaser does not receive a Section 116 Certificate from a non-resident vendor prior to closing, such purchaser is required to withhold 25% to 50% of the purchase price and remit such amount to the CRA.
According to the Act, when a purchaser has made a “reasonable inquiry” and believes that a vendor is a Canadian resident, a purchaser may be relieved of its tax liability under Section 116 of the Act. While each case is reviewed by the CRA on an individual basis, a purchaser is required to take prudent measures to confirm the residency of a vendor if it wants to avoid tax liability. Typically, a representation made by the vendor that it is “not a non-resident of Canada” is considered to be a reasonable inquiry into the residency of a vendor. If after such inquiry the purchaser has no reason to believe that the vendor is a non-resident of Canada, the purchaser should be relieved from the tax liability.
Test for Determining Residency
In tax law, the concept of residency is applied to individuals as well as other taxable entities, such as corporations. However, residency is not defined in the Act. For Canadian tax purposes, our current test is a combination of place of incorporation and central management and control. In 1965, Canada enacted the place of incorporation test, which deems a corporation to be resident in Canada if it was incorporated in Canada after April 26, 1965.
A corporation incorporated in Canada before April 27, 1965 will be deemed to have been resident in Canada throughout a taxation year if at any time after April 26, 1965, it was resident in Canada under the central management and control test or it carried on business in Canada, provided that its residency is not resolved in favour of another jurisdiction under the terms of a tax treaty. Further, a corporation that is not deemed resident in Canada under the place of incorporation test may still be a resident of Canada under the central management and control test.
The De Beers case, a British decision, remains one of the leading authorities on the central management and control test. In De Beers, the court held that the test of residence is not where a corporation is registered, but where the central management and control is actually exercised as a matter of fact.
Dual Residency and Tax Treaties
It is worth noting that there are situations where a corporation can be resident in Canada and another country at the same time under the domestic laws of each country. Where competing laws would make a corporation resident in Canada and another country at the same time, the “tie-breaker” rules in a tax treaty between Canada and such other country, if one exists, often override the domestic laws to resolve the residency issue. When a corporation is no longer a Canadian resident pursuant to common law, statute or treaty and becomes a non-resident, section 116 of the Act may apply in the event of a sale of such non-resident’s assets. However, a tax treaty may apply to reduce or eliminate the tax payable by such non-resident vendor.
In situations where ascertaining the residency of a corporation through a reasonable inquiry may be challenging, it is possible to obtain a certificate of residency from the CRA. A certificate of residency confirms that a taxpayer is, in fact, a resident of Canada for tax purposes. A number of foreign countries also provide a similar type of certificate to confirm that a taxpayer is resident in that particular country for tax purposes.
In some cases, confirmation of corporate residency is a straightforward analysis. However, the potential application of statutory deeming rules and the interpretation of Canadian law and foreign law may trigger unexpected results in certain circumstances. It is true that a corporation is generally deemed to be resident in Canada if it was incorporated in Canada after April 26, 1965. However, while the place of incorporation is an important initial determinant of residency, it is not the only determinant. If the domestic laws of Canada and another country would deem a corporation resident in two countries at the same time, the issue must be resolved by referring to the tax treaty between the two countries, if one exists. In all transactions involving the purchase and sale of TCP, a purchaser should protect itself by taking prudent measures to confirm the vendor’s residency status and proceed accordingly.
