28 November 2010 Roundtable, 2010-0386071C6 - Section 216 Returns - Capitalized Expenses

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether a non-resident person who files a section 216 return and computes (under Part I of the Act) the person's tax liability in respect of the rental income from a rental building located in Canada can use capitalized expenses to reduce or eliminate the capital gain on the subsequent sale of the building?

Position: No

Reasons: Section 216 specifically provides that the non-resident person shall pay tax under Part I on the rental income without affecting the tax otherwise payable by the person under Part I of the Act

2010 CTF Conference – November 28, 2010

Section 216 Return – Capitalized Expenses

Assume that a non-resident taxpayer acquires a rental building in Canada and that the rental income on the building is not taxable under Part I of the Act. The taxpayer is eligible, pursuant to subsection 216(1) of the Act, to file a return under Part I in lieu of paying tax under Part XIII.

Assume that in the year the building was acquired and the following taxation year, the taxpayer filed a section 216 return and, in computing the income from the building under Part I of the Act, the taxpayer elected under section 21 of the Act to add to the capital cost of the building certain interest expenses incurred by the taxpayer. At the beginning of the third taxation year, the taxpayer disposes of the building for proceeds of disposition that exceed the taxpayer's original cost.

Question

Given that subsection 216(1) of the Act states that the non-resident taxpayer is liable to pay tax on the rental income from the building under Part I without affecting the tax otherwise payable by the non-resident taxpayer under Part I of the Act, does the CRA take the position that the taxpayer is required to compute the capital gain from the disposition of the building without reference to the amounts added to the capital cost of the property under section 21?

CRA Response

In general, subsection 216(1) of the Act provides that where, in a taxation year, a non-resident person receives an amount on account of, in lieu of, or in satisfaction of, rent on real property in Canada, the non-resident person may elect to be taxed under Part I of the Act in lieu of paying tax under Part XIII. The non-resident makes the election by filing a special Part I return and by paying the amount of tax, if any, computed under Part I for the year as if the rent from the property were the non-resident's only income.

Subsection 216(1) also provides that a non-resident person who files a section 216 return shall pay tax under Part I "without affecting the liability of the non-resident person for tax otherwise payable under Part I." The prohibition against affecting the non-resident's tax otherwise payable under Part I appears to serve two purposes: first, it ensures that the section 216 return is separate from any other return that the non-resident may be required to file under Part I and; secondly, it ensures that the filing of the separate return does not affect the tax that the non-resident is otherwise required to pay under Part I of the Act. In our view, section 216 provides a non-resident person with the opportunity to reduce or eliminate the non-resident's liability tax under Part XIII but it does not allow the non-resident to reduce or eliminate any capital gain that may be realized on the subsequent disposition of the property.

To ensure that an amount added to the capital cost of the property under section 21 does not affect the tax that would otherwise be payable by the non-resident person under Part I from the disposition of the property, the CRA will allow an addition to the capital cost of the property but only for the purpose of computing capital cost allowance (and recapture) on a section 216 return. Applying section 216 in this way places the non-resident person in the same position with respect to the computation of the capital gain from the property as if no section 216 return had been filed (or, if filed, the non-resident had not elected to add the financing expenses to the cost of the property). In our view, this approach is consistent with the purpose of section 216 (i.e., to provide relief from Part XIII tax without affecting tax otherwise payable under Part I) while not imposing any limits on the computation of income from the property on the section 216 return.

This assessing position will apply to capitalized expenses incurred after 2010. The CRA will apply this assessing position to interest expense incurred before 2011 if the interest is payable to a person that is not dealing at arm's length with the non-resident taxpayer and the arrangement at issue does not, in our view, reflect arm's length commercial dealings.

Judith Nichols
2010-038607