Tax Considerations for Real Estate Investments by Non-Residents of Canada

Canadian income taxes are complex and the taxation of Canadian real estate depends on whether the use of the property is for a principal residence, an active business or as a rental property.

If the purchase is used as a home and principal residence, any gains on a future sale will not be taxed. If the property was first used as a rental property and then changed to a principal residence, taxes will apply on any gains calculated from the cost on the date purchased to the fair market value at the date of the change in use. Residents of Canada are eligible for tax rebates known as GST and land transfer tax on "newly constructed" homes.

Business Income

The distinction is not always clear what is business or rental income, however, it is important because the tax treatment is different. Generally, the greater the size and extent of the rental properties and the time required for service and management, the greater the likelihood you are operating a business.

Non-resident corporations carrying on a business in Canada through (a) a local corporation, are taxed at the same rates (43%) as applied to Canadian corporations or (b) an unincorporated foreign branch, will be taxed at 25%, which is subject to a reduction by any tax treaty. Presently Canada has no treaty with Hong Kong. Treaties with Singapore and Malaysia for branch profits is 15%.

A non-resident earning rental income has a choice of how the income is taxed:

(a) pay 25% on the gross rents including recoverable expenses received OR

(b) make an annual election on a prescribed form must be filed to Revenue Canada by January 1^st every year to pay tax on the net rental income by filing a Canadian income tax return for the net rental income only. If the tax return is filed late or not at all, the non-resident will be taxed 25% of the gross rents with interest and penalty.

A calculation should be done to determine which alternative is best.

Where the election is made by a non-resident individual, the individual will be taxed at graduated tax rates normally applicable to Canadian residents starting at 25% up to $31,100 CAN and reaching about 50% on net income exceeding $100,000CAN. Where the election is made by a non-resident corporation, the combined federal and provincial corporate tax rate is approximately 43% on the net rental income and in certain circumstances could be as high as 53%.

A 25% withholding tax on the monthly rent collected is normally remitted to Revenue Canada. However, if you and your appointed property manager file the election form (mentioned in (b)) by January 1^st, to pay tax on the net rent on a Canadian tax return, it is possible to reduce or eliminate the monthly withholding tax by including a budget that shows little or no profit.

The tax treatment of any gains on the sale of Canadian real estate depends on whether the gain is treated as a capital gain or business income. Generally, if the non-resident is actively buying and selling real estate as inventory, then the operation is likely to be considered a business and will be taxed on the full amount of the gain.

If the gain is a capital gain, the normal Canadian tax rates will be applied to 50% of the gain. However, a non-resident is required to pay an estimate of the tax before the sale, an amount equal to 25% of the gain. Upon payment, Revenue Canada will issue a clearance certificate to the vendor. If a purchaser does not receive this certificate from the vendor, they are required to withhold and remit to Revenue Canada 33.3% of the gross purchase price from the vendor!

GST of 7% applies on the purchase and sale of homes and any commercial property. There is no GST on residential rent, there is GST for rent on commercial property if the annual gross rent received is over $30,000 per year per taxpayer.

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