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Fall 2007
Volume 7, Number 3
The information in Tax Perspectives is prepared for general interest only. Every effort has been made to ensure that the contents are accurate. However, professional advice should always be obtained before acting and TSG member firms cannot assume any liability for persons who act on the basis of information contained herein without professional advice.
Non-Residents Buying Canadian Real Estate
As the economy becomes more global, many people are buying real estate in other countries. The reason could be simply wanting a foreign vacation home, or diversifying an investment portfolio by owning income-producing property in another part of the world.
More and more non-resident clients have been buying Canadian real estate. As with all cross-border transactions, there are many tax issues with which they are required to comply.
This article outlines the Canadian tax legislation concerning non-residents who purchase and rent property in Canada, including possible ways to reduce tax.
Suppose we have a fictitious client, Robert, resident in London, England. He has decided to expand his real estate portfolio by purchasing a condominium in downtown Toronto that he plans to rent. He has no plans to live in the property, and hopes to sell it in future for a large capital gain.
As a non-resident of Canada, Robert is required to have 25% of the gross rental income withheld and remitted monthly to the Canada Revenue Agency ("CRA"), within fifteen days of each month-end, either by the tenant or by a Canadian agent nominated by Robert.
A summary of the gross rent paid to Robert and the tax withheld on that rent must be provided to the CRA by March 31 in each calendar year on form NR4 "Statement of Amounts Paid or Credited to Non-residents of Canada". If tax is not withheld, interest will likely be charged by the CRA from the date of each rent payment, plus a 10% penalty.
If Robert so wishes, this could be his only Canadian tax report. Robert would declare his rental income to the U.K. tax authorities, and use the Canadian income tax withheld as a foreign tax credit on his U.K. return. However, 25% of the gross rent is a considerable amount of tax. Depending on the level of expenses, it may exceed the eligible U.K. tax credit.
To reduce the Canadian income tax payable, Robert can elect to file a Canadian personal income tax return reporting only his Canadian rental income. The return, required under Section 216 of the Canadian Income Tax Act, is due two years after the year-end. By filing this return, Robert may obtain a partial or full refund of the tax remitted to the CRA.
Robert would report on the return his gross rental income and deduct expenses such as property taxes, repairs and maintenance, interest on debt used to purchase the property, condominium fees, depreciation, property management fees, etc. Tax will be calculated on the net rental income at graduated personal tax rates. The lowest personal tax rate in Ontario is approximately 20% on up to about $37,000 of annual taxable income.
Whether filing a tax return is beneficial will depend on Robert’s expenses, which are deductible from net rental income. The top personal tax bracket in Ontario for an individual is around 46%. So, if the income is very high and the expenses are low, the election may not be beneficial.
By adjusting the level of debt financing, a break-even can be structured. The level of debt is a personal choice, but most non-residents will have difficulty borrowing in Canada more than 65% of the property value. The interest rate and the debt level may be negotiated with a Canadian bank. Interest will be deductible if paid on debt used to purchase the property, whether the lender is Canadian or foreign. However, non-resident withholding tax will apply on foreign debt secured on Canadian property. (Under recent proposals, the withholding tax may soon be eliminated on arm’s length debt.)
The appropriate rent will best be investigated by a local real estate broker. The broker may also manage the property, find tenants and pay expenses as agent for a fee, which will be deductible.
If the property is residential, no goods and services tax (GST) is payable on the rental income, and no credit is given for GST paid. For commercial property, GST registration may be required, which will probably be beneficial.
To improve cash flow, Robert can file form NR6, requesting that tax be withheld at 25% on the estimated net income, rather than on the gross income. This form should be filed annually prior to receiving any rent for the year. A statement showing expected gross rent and expenses (other than depreciation) must accompany form NR6. Robert should provide the required information to his Canadian tax adviser by November or December of the prior year. By filing this form, Robert will reduce the tax initially remitted to the CRA. Form NR6 requires that the non-resident assign an agent to remit withholding tax and to deal with the CRA. The agent is jointly and severally liable for the tax, which sometimes makes it difficult to find a volunteer agent. When form NR6 is filed, the Section 216 return must be filed by June 30th of the following year (18 months earlier than otherwise).
When Robert’s property is sold, a 25% withholding tax will apply to the gross proceeds. This can be reduced, by requesting a special clearance, to 25% of the net capital gain. The gain is taxable in Canada. Under Canadian rules, 50% of the gain, and any depreciation previously claimed, will be reported on Robert’s Canadian personal tax return and taxed at Canadian personal tax rates. Curiously, the return is filed separately from the Section 216 return.
As will be appreciated from the foregoing, owning Canadian rental real estate is complicated. The CRA has been much stricter recently in applying these rules. Penalties for late filing, or for failure to withhold, will be applied by the CRA. Consequently, care must be taken to follow all the rules.
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