Can a Home Buyer Be Responsible for the Seller’s Unpaid Tax?
Most homebuyers focus on financing, inspections, and closing costs. Few think about non-resident seller Canada tax withholding obligations before signing the transfer documents. However, missing that issue can lead to a significant CRA assessment, even where the buyer acted in good faith.
Kau v. The Queen, 2018 TCC 156, is a Tax Court of Canada decision that illustrates exactly how that exposure arises, what the law requires, and what a buyer can do to avoid it.
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The Facts
A buyer purchased a condominium in Toronto from a seller who had several connections outside Canada. Before closing, the buyer obtained a brief written statement from the seller confirming Canadian residency. Relying on that statement, the buyer paid the full purchase price and completed the transaction.
The CRA subsequently assessed the buyer for approximately $92,000, taking the position that the buyer should have withheld tax under section 116 of the Income Tax Act. The matter proceeded to the Tax Court of Canada.
What Section 116 of the Income Tax Act Requires
Section 116 of the Income Tax Act can require a purchaser to withhold and remit tax when acquiring taxable Canadian property from a non-resident seller, unless a certificate of compliance or another relieving rule applies. For many ordinary real estate sales, the purchaser’s exposure is generally 25% of the purchase price where the issue remains unaddressed before closing. In Kau, a purchase price of approximately $368,000 produced an assessment of roughly $92,000; exactly 25%.
The withholding obligation falls on the buyer. Consequently, a buyer who pays the full purchase price to a non-resident seller without first addressing the withholding requirement can become personally liable to the CRA for the amount that should have been withheld.
Where the seller is or may be a non-resident, the usual approach is to address the section 116 certificate process early. The seller applies to the CRA, and the transaction should generally not close without either the certificate process being addressed or an appropriate holdback arrangement being in place. CRA Information Circular IC72-17R6 sets out the procedural requirements for non-resident dispositions of taxable Canadian property and provides guidance on how compliance is achieved in practice.
The Central Issue: Reasonable Inquiry
The Tax Court focused on one key question: did the purchaser make a reasonable inquiry into the seller’s residency status before closing?
Under paragraph 116(5)(a), a purchaser can avoid liability where the purchaser had no reason to believe the vendor was a non-resident. However, that protection applies only where the purchaser genuinely had no reason for doubt. Where facts known at closing raised questions about the seller’s residency, the buyer carries the obligation to investigate further before completing the purchase.
In Kau, the Court examined the facts available to the buyer at closing and concluded those facts required further inquiry. Because the buyer completed the purchase without conducting that inquiry, the buyer remained liable under section 116 and the appeal was dismissed.
The Warning Signs the Court Identified
The Court pointed to several facts that should have prompted the buyer to investigate further before closing:
- A California address for service appeared on the closing documents
- The documents themselves were signed in California
- The property was an investment property rather than the seller’s principal residence
- The residency confirmation was a brief, unsworn statement rather than a formal statutory declaration
Taken together, those facts were enough to place the buyer on notice. A brief written statement from the seller, standing alone, was insufficient where the surrounding circumstances cast doubt on the seller’s residency.
Worth noting: where there are no contrary facts suggesting non-residency, purchasers often rely on a statutory declaration from the seller regarding residency. Kau shows that where red flags exist, a bare statement will not be enough.
Why the $92,000 Assessment Was Upheld
The Court concluded that the buyer had fallen short of the reasonable inquiry standard required under paragraph 116(5)(a). Because the buyer had not made reasonable inquiry and had paid the full purchase price to the seller, the withholding obligation under subsection 116(5) applied. The purchaser remained liable for the amount that should have been withheld, and the appeal was dismissed.
What This Means for Buyers, Investors, and Advisors
This case is directly relevant to anyone involved in a Canadian real estate transaction where the seller’s residency status is unclear, including:
- Individual homebuyers purchasing from a seller with foreign connections
- Real estate investors acquiring income-producing properties
- Lawyers and notaries advising on residential or commercial closings
- Accountants and tax advisors involved in cross-border transactions
The starting point for managing this risk is straightforward. Before closing on any Canadian real estate transaction, take the following steps:
1. Ask about the seller’s residency status early Raise the question of residency at the outset of the transaction. Early identification of a potential non-resident situation gives all parties time to address it properly before closing day arrives.
2. Address the certificate of compliance process where required Where the seller is or may be a non-resident, the seller applies to the CRA for a certificate of compliance, usually by providing transaction details and paying or securing the amount required under the section 116 rules. The transaction should generally not close without either the certificate process being addressed or an appropriate holdback arrangement being in place.
3. Assess the facts, not just the seller’s statement A brief written statement from the seller confirming residency provides some comfort; however, it carries less weight where surrounding facts raise doubt. A foreign address, documents executed abroad, or an investment property without local ties are all facts worth examining before accepting a residency assertion at face value.
4. Follow CRA guidance on procedures CRA Information Circular IC72-17R6 sets out the procedural framework for non-resident dispositions in detail. Advisors and buyers involved in cross-border transactions should be familiar with its requirements before closing day arrives.
5. Seek advice before closing The options available to a buyer narrow considerably once the purchase price has been paid. Early tax planning gives everyone involved the time to structure the transaction in a way that protects the buyer from unexpected withholding liability.
Final Thoughts
Kau v. The Queen is a useful reminder that a buyer’s obligations under the Income Tax Act extend beyond the purchase agreement itself. Where a non-resident may be selling taxable Canadian property, the withholding obligation follows the buyer, and a brief statement from the seller is rarely sufficient where the surrounding facts give reason for doubt.
Build the inquiry process into every transaction from the start. The cost of getting it right before closing is a fraction of the exposure that can arise after.
Sources
Full decision: https://www.canlii.org/en/ca/tcc/doc/2018/2018tcc156/2018tcc156.html
ITA s. 116 Disposition by non-resident person of certain property: https://laws-lois.justice.gc.ca/eng/acts/I-3.3/section-116.html
CRA IC72-17R6 Procedures Concerning the Disposition of Taxable Canadian Property by Non-Residents of Canada: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/ic72-17/ic72-17r6-procedures-concerning-disposition-taxable-canadian-property-non-residents-canada-section-116.html
At Cloudiverse CPAs in Burnaby, we assist clients with section 116 compliance, certificate of compliance applications, and cross-border tax planning so that potential issues are identified well before closing day.
Reach out directly: Email: aman@cloudiverse.ca Phone: 604-200-4027 Book a free 30-minute discovery call: https://www.cloudiverse.ca/book-a-free-30-minute-discovery-call/
Disclaimer: This blog is for general informational purposes only and does not constitute legal or tax advice. Every situation is unique. Please consult a qualified tax professional before relying on this information for your own circumstances.