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 forfeited deposit in respect of a cancelled sale of real property in Canada owned by a non-resident is subject to section 116.
Position: Generally, no.
Reasons: Generally, the nature of the deposit is a security interest in respect of the agreement for sale which is excluded from being an interest in real property by subsection 248(4) and therefore not taxable Canadian property as defined by subsection 248(1).
March 16, 2015
HEADQUARTERS Income Tax Rulings Directorate
Specialty Audit Division International Division
Small and Medium Enterprises
Directorate Robert Demeter
Compliance Programs Branch (613) 670-9044
Attention: Claudio DiRienzo
Policy and Technical Advisor 2013-047986
Forfeited deposits in respect of a cancelled sale of non-resident owned Canadian real property
This is in reply to your email of February 26, 2013, in which you requested our views as to the application of section 116 of the Income Tax Act to forfeited deposits in respect of a cancelled sale of Canadian real property owned by a non-resident. We also acknowledge our telephone conversation and further email correspondence of May 2 and 3, 2013 concerning this issue (Moore/DiRienzo).
In particular, you have described a situation with the following facts:
- A non-resident of Canada owns Canadian real property located in British Columbia.
- The non-resident has entered into an agreement for sale in respect of the Canadian real property.
- The non-resident vendor has accepted a deposit under the agreement for sale.
- It is expected that the buyer will be unable to complete the transaction resulting in the cancellation of the agreement for sale and that the deposit will be forfeited to the non-resident vendor under the terms of the agreement.
You would like to know whether the forfeited deposit is subject to section 116 of the Act.
For section 116 to apply, there must be a disposition of property by a non-resident person, and the property disposed of must be taxable Canadian property (other than property described in subsection 116(5.2) and excluded property).
Where a buyer has failed to complete a purchase pursuant to the terms of an agreement for sale, and as a result, the buyer has forfeited their deposit to the vendor, it has been the CRA's long-standing position that a disposition of a right under a contract has occurred, resulting in either income or a capital gain to the vendor. In support of this view, we refer to subparagraphs (b)(i) and (ii) of the definition of "disposition" at subsection 248(1) if the Act, noting that a disposition of any property includes:
"(b) any transaction or event by which,
(i) where the property is a[n]
agreement of sale or similar property, or interest, or for civil law a right, in it, the property is in whole or in part redeemed, acquired or cancelled,
where property is a debt or any other right to receive an amount, the debt or other right is settled or cancelled,".
As such, it continues to be our view that there is a disposition of a right under a contract where an agreement of sale has been cancelled and the buyer's deposit is forfeited to the vendor. However, this is not to say that there would be a disposition of taxable Canadian property in such circumstances.
For this purpose, we have considered the definition of taxable Canadian property in subsection 248(1), which includes:
"a property of the taxpayer that is
(a) real or immovable property situated in Canada,
(b) property used or held by the taxpayer in, eligible capital property in respect of, or property described in an inventory of, a business carried on in Canada
(f) an option in respect of, or an interest in, or for civil law a right in, a property described in any of paragraphs (a) to (e), whether or not the property exists,
When examining whether real property or an interest in real property is taxable Canadian property, attention must be paid to subsection 248(4). Subsection 248(4) states that, for the purposes of the Act, "an interest in real property
does not include an interest as security only derived by virtue of...a[n]
agreement for sale or similar obligation." Where the property is a security interest derived by an agreement for sale, it is excluded from being an interest in real property and is thereby excluded from the definition of taxable Canadian property.
At common law, a deposit in respect of an agreement for the sale of real property has been viewed as an earnest or security for the performance of the purchase and sale, unless there is evidence that the contract requires otherwise. The seminal case on the nature of deposits in real property transactions is the 1884 decision of the English Court of Appeal in Howe v. Smith. (endnote 1) In Howe v. Smith, a deposit was described as: "a guarantee that the contract shall be performed"; "a security for the completion of the purchase"; and "an earnest to bind the bargain so entered into, and creates by the fear of its forfeiture a motive in the payor to perform the rest of the contract." (endnote 2) Where an amount is described as both a deposit and partial payment, these two concepts are alternatives such that the amount is a partial payment only once the purchase is actually completed. (endnote 3)
The B.C. Court of Appeal recently reviewed the case law on the nature of deposits and their forfeiture in real property transactions in the case of Tang v. Zhang. (endnote 4) In Tang v. Zhang, the Court noted that Howe v. Smith had been adopted by the Supreme Court of Canada and that it also accorded with the current law of British Columbia. (endnote 5)
According to the cases of Howe v. Smith and Tang v. Zhang, where the agreement between the buyer and vendor states that the amount is a deposit, it is treated as such unless a contrary provision is present in the agreement, and its legal nature as a deposit must then generally be respected in applying the Act. (endnote 6) While it may be possible for an agreement to use the word "deposit" but actually create something else, the legal nature of an amount must be determined on a case-by-case basis, considering all the facts surrounding the contract's formation, and we have not been provided with an actual agreement for sale in the current context. However, it should be noted that, according to the B.C. Court of Appeal, the nature of a deposit will not be altered by a term of an agreement saying that the amount will be forfeited on account of damages. (endnote 7)
In the situation which you have described and on the basis of the foregoing, should the buyer be unable to complete the purchase and therefore, forfeit the deposit to the non-resident vendor, we are of the opinion that there would be a disposition of a security interest derived by virtue of an agreement for sale or similar obligation. Since the property disposed of would not be an interest in real property for the purposes of the Act, it would not be taxable Canadian property and would not be subject to the application of section 116. However, upon forfeiture, the deposit, or a portion of it, may still be taxable in the hands of the non-resident vendor as income or a capital gain sourced in Canada. (endnote 8)
We wish to stress that we have not examined the actual agreement for sale and nothing in this letter should be taken as our views as to whether the particular agreement at hand causes the amount in question to be something other than a deposit.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.
We hope our comments are of assistance to you.
Robert A. Demeter, CPA, CGA
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
1 (1884) 27 Ch D 89.
2 Ibid at 95, Cotton LJ; ibid at 98, Bowen LJ; ibid at 101, Fry LJ.
3 Ibid at 95, 102.
4 2013 BCCA 52.
5 Ibid at para 24.
6 Consider the comments of McLachlin J. (as she then was) in Shell Canada Ltd v. Canada, "absent a specific provision of the Act to the contrary or a finding that they are a sham, the taxpayer's legal relationships must be respected in tax cases." Shell Canada Ltd v. Canada,  3 S.C.R. 622, 1999 CanLII 647 at para 39.
7 Tang v. Zhang, supra note 4 at paragraph 30.
8 See Interpretation Bulletin IT-334R2, Miscellaneous Receipts, at paragraph 8.
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