Distributions from the estate of a Canadian resident to a non-resident can give rise to additional compliance obligations under section 116 of the Income Tax Act where the estate owns Canadian real estate. The need for such a clearance certificate is determined based on the value of real estate held by the estate in relation to the total residual value of the estate. Given the current boom in the Canadian housing market, compliance with section 116 obligations is becoming increasingly more common.
The determination of whether a section 116 clearance certificate is necessary involves a two-step analysis. First, it is necessary to determine if the property being disposed of by the non-resident of Canada (i.e some or all of the person’s capital interest in the estate) qualifies as taxable Canadian property (“TCP”). A capital interest in an estate will qualify as TCP if at any time in the 60 months before a distribution in respect of the interest in the estate (but not including any time before the deceased individual’s death), more than 50% of the estate’s residual value (i.e after deducting all debts and legacies to be paid by the estate), derives from real property. As a result, if the value of an estate’s assets fluctuate or the relative value of the non-real estate to real estate assets shifts, an estate interest can become TCP, and that characterization will apply into the future for 60 months (the “TCP-requirement”). If the TCP-requirement is met, a clearance certificate is necessary unless the interest in the estate qualifies as excluded property. One category of excluded property is treaty-exempt property.
This brings us to the second part of the analysis, which assesses whether the property in question is “treaty-exempt” property. For example, in the case of an estate with non-resident beneficiaries in the United States, we look to the Canada-US Tax Treaty, which provides that an interest in an estate will be considered to be real property if more than 50% of its value is derived from real property (the “Treaty-requirement”). Of significance, in the Canada-US Tax Treaty, this requirement is a point in time assessment, such that it only looks to the value and composition of the estate at the time the relevant distribution is made. The Canada-US Tax Treaty further provides that if an interest in a Canadian estate is not real property, any gains arising from a disposition of an interest in that Canadian estate are not taxable to a US non-resident; this then means that the non-resident’s interest in the estate is treaty-protected property. Of significance, Canada’s tax treaties vary on this issue, with some treaties (eg. the Canada-Israel Tax Treaty) providing less protection in that regard than the Canada-US Tax Treaty.
To then go on and determine whether the treaty-protected property is treaty-exempt property (and therefore excluded property and exempt from s. 116 compliance), the relationship of the trustees to the recipient beneficiary must be considered. If the non-resident beneficiaries and the estate executors are not-related for income tax purposes – generally meaning that they are not linearly related – then if the estate is treaty-protected property, it will also be treaty-exempt property.
Depending on the country of residence of non-resident beneficiaries, sky-rocketing housing prices, as well as the timing of distributions from the estate’s non-real estate assets, may have the added consequence of compliance with section 116. As a result, executors of Canadian estates should seek legal assistance prior to making any distributions to non-residents.