Changes to Rules for Canadian Property Dispositions by Non-Residents
Canada taxes non-residents on their gains from the disposition of taxable Canadian property (TCP). Recent amendments have aligned Canada’s rules more closely with Canada’s tax treaties, thereby eliminating Canadian tax on gains from the disposition of Canadian investments in many cases and enhancing the ability of Canadian business to attract foreign investors (see Relief for Non-Residents of Canada on Canadian Property Dispositions, Tax Update dated April 26, 2010).
In particular, unlisted shares of most corporations or interests in a partnership or trust will be considered TCP at a particular time only if, at any time during the preceding 60 months, more than 50% of the shares’ fair market value was derived directly or indirectly from a combination of:
- real or immovable property situated in Canada;
- Canadian resource properties;
- timber resource property and options; and/or
- interests or civil law rights therein (i.e., "look-through" rule).1
This definition of TCP is consistent with a general international tax principle — that the country in which immovable property is located should have the right to tax the gains from the disposition of such property.2 For example, the OECD3 Model Tax Convention on Income and on Capital (OECD Model Convention) provides that gains "from the alienation of shares deriving more than 50% of their value directly or indirectly from immovable property" situated in a country may be taxed in that country.4
Two recent changes to the rules and their application should be noted.
1. Valuation Method
The Canada Revenue Agency (CRA) has announced a change in its administrative policy for determining whether shares of a corporation derive their value principally from Canadian property.5
Previously and in the context of treaties, when determining whether a share of a company derives its value principally from real or immovable property situated in Canada, the CRA has permitted a taxpayer to use the gross asset value method, the net asset value method or any other method appropriate in the circumstances. Moreover, the CRA has stated that for this purpose, it will accept a valuation method that assigns the debt of a corporation to the assets to which the debt reasonably relates. The CRA took this position even though the Commentary to the OECD Model Convention6 provides that one will normally conduct the test by referring to the value of the property of the corporation, without taking into account its debts or other liabilities.
The CRA has now determined that its approach in the context of treaties and when interpreting the definition of TCP should be in line with the Commentary to the OECD Model Convention. This means that the determination as to whether a share of a corporation derives its value principally from real or immovable property situated in Canada should be made by reference to the value of the properties of the corporation without taking into account its debts or other liabilities (i.e., the gross asset value method).
The CRA’s new restrictive position will initially be applied only with respect to dispositions of properties acquired after 2011. Non-resident taxpayers disposing of property already held by them in 2011 will continue to be able to choose any valuation method they wish, provided that the sale takes place before 2013. For sales of property that take place after December 31, 2012, the CRA will follow the gross asset value method in respect of all property dispositions.
In light of these changes to the CRA administrative position, non-residents holding Canadian investments where the net asset value method results in less Canadian tax payable may wish to restructure their ownership during 2012.
2. Relief From "Look-Through"
Draft legislation released August 27, 2010 prevents the indirect "look-through" to the property of a corporation, trust or partnership, where the shares of the corporation or interest in the trust or partnership would not themselves be TCP.7 For example, a non-resident may own, through a private holding corporation, shares of a Canadian public corporation that derive most of their value from real or immovable property situated in Canada. In such circumstances, it is possible that the shares of the private holding corporation could otherwise be TCP by virtue of the look-through to the real property, even though a direct holding by the non-resident of the public corporation shares might not be TCP. This amendment is intended to ensure that in these circumstances the look-through rules do not apply where the public corporation shares are not themselves TCP.8
The CRA has confirmed9 that if the draft legislation amending the definition of TCP is enacted as proposed, it will take this new rule into account in the determination of whether shares of a corporation derive their value principally from real or immovable property situated in Canada.
This is particularly relevant where the shares of a corporation (Subsidiary) are held by another corporation (Parent) and would not themselves be TCP. According to this new rule, the full value of the shares of the Subsidiary owned by the Parent will be viewed as property other than real or immovable property situated in Canada in the determination of whether the shares of the Parent derive their value principally from real or immovable property situated in Canada.
1 Paragraph (d) of the definition of TCP in subsection 248(1) of the Income Tax Act (Canada) (ITA)
2 The explanatory notes in the March 4, 2010 budget indicate that the TCP definition changes were in part to make the domestic rules more consistent with Canada’s tax treaties.
3 Organization for Economic Co-Operation and Development
4 Article 13(4) of Model Tax Convention on Income and on Capital (Paris: OECD, 2010)
5 At the 63rd Annual Conference of the Canadian Tax Foundation, November 29, 2011
6 Paragraph 28.4 of the Commentary
7 Proposed amendment to paragraph (d) of the definition of TCP in subsection 248(1) of the ITA
8 The September 12, 2010 explanatory notes to the August 27, 2010 draft legislation set out this example and comment.
9 See supra note 5