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 Part XIII tax applies to certain payments made by a Canadian resident individual under a rental arrangement for a real property situated in Canada and owned by a related non-resident individual.
Position: Payments of rent to the non-resident individual and payments made by the Canadian resident individual for and on behalf of such non-resident individual to third parties that are attributable to the ownership of the real property rather than the occupation of the property are subject to Part XIII tax.
Reasons: The payments meet the requirements of paragraph 212(1)(d).
October 3, 2014
International and Ottawa Tax Services Office Income Tax Rulings Non-Resident Withholding Division Directorate
Attention: Denis Guay International
Withholding tax implications for various payments made by a Canadian resident individual in respect of the use of a real property situated in Canada and owned by a related non-resident individual
We are writing in response to your email of May 12, 2014 in which you requested our view as to whether various payments for the use of real property made by a Canadian resident individual to a non-resident related individual, or to third parties (such as a utility company and a municipality) on behalf of that non-resident individual, would be subject to withholding tax under Part XIII of the Income Tax Act (the "Act").
Unless otherwise stated, every reference herein to a Part, Division, section, subsection, paragraph or subparagraph is a reference to the relevant provisions of the Act.
The following hypothetical circumstances will be used to address your request:
A non-resident individual (the "Owner") owns real property situated in Canada (the "Real Property") and allows an individual (the "Tenant") to whom the Owner is related, within the meaning assigned by subsection 251(2)(a), to occupy the Real Property on the conditions described below:
Scenario 1: The Tenant pays an agreed amount to the Owner on a periodic basis; however, the amount of the payment is lower than the amount the Owner would have been able to receive had the Owner rented the Real Property to an unrelated person (i.e., the payment received by the Owner is below the fair market value rent for the Real Property).
Scenario 2: The Tenant does not make any payments to the Owner but is responsible for paying all expenses associated with the Real Property, including utilities and property tax.
The Owner allows the Tenant to live in the Real Property because of their personal relationship, i.e., it is not a commercial undertaking.
You enquired as to whether the payments made by the Tenant to the Owner in Scenario 1 or the payments made by the Tenant to third parties in Scenario 2 would be subject to Part XIII withholding tax.
In our view, all payments made by the Tenant in Scenario 1 and certain payments made by the Tenant in Scenario 2 would represent either rent or similar payments and, as such, would meet the conditions of paragraph 212(1)(d) and be subject to Part XIII withholding tax.
Application of Part XIII tax to the payments in question
Where a non-resident person carries on business in Canada and uses a real property situated in Canada in that business, the non-resident person is taxed under subsection 2(3) on the net basis (Part I tax). However, where the holding of the real property does not constitute a business, the non-resident is taxed on gross receipts under Part XIII (unless the non-resident elects under section 216 to pay tax on the net basis).
Based on the facts as described above, it is assumed that the Owner does not carry on business in Canada. Therefore, the only relevant taxation regime would be under Part XIII.
Paragraph 212(1)(d) of Part XIII states that every non-resident person shall pay an income tax of 25% (footnote 1) on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to the non-resident person as, on account or in lieu of payment of, or in satisfaction of, rent, royalty or similar payment, including, but not so as to restrict the generality of the foregoing, any payment for the use of or for the right to use in Canada any property. (footnote 2)
Neither paragraph 212(1)(d) nor any other provision in Part XIII contains a definition of the term "rent". (footnote 3) However, based on our long standing position and the applicable jurisprudence (footnote 4), a rent normally refers to a payment (either periodic or a lump sum) that is consideration for the use or the right to use property for a term, whether fixed in time or otherwise determinable, after which the right of the grantee to the property and to its use reverts to the grantor.
The determination of whether a specific arrangement would constitute a rental agreement is a question of law, and such determination would depend on the contract concluded between the parties. However, for the purpose of our comments below, we will assume that the arrangement between the Owner and the Tenant constitutes a rental agreement since it appears to contain characteristics that we would generally expect to see in a rental agreement: the Tenant enjoys temporary possession of the Real Property after which the right to use the Real Property will be returned to the Owner, the Owner retains the ownership of the Real Property at all times and the Tenant makes certain payments for the use of the Real Property.
The payments made by the Tenant to the Owner in Scenario 1, in our view, would be considered rent, provided the payments cannot be attributed to anything other than for the use of the Real Property by the Tenant. As a result, the payments would be subject to withholding tax at 25% under paragraph 212(1)(d).
The fact that the amount of rent in Scenario 1 is lower than what the Owner would have been able to receive had the Owner rented the property to an unrelated person would not impact the characterization of the payment as rent for purposes of paragraph 212(1)(d).
Further, the fact that the amount of rent in Scenario 1 is below the fair market value would also not, in our view, impact the amount subject to withholding tax under paragraph 212(1)(d). We are of this view because it is our understanding that the transfer pricing rules in section 247 would generally not be applied to adjust the amount of rent under the circumstances described in the scenario.
Some or all of the payments made by the Tenant to third parties (such as for utilities and property tax) would, in our view, also be subject to withholding tax under paragraph 212(1)(d). The extent of the Part XIII tax liability would depend on the extent the payments represent payments for the use of the Real Property (as opposed to, for example, payments for the use of the services provided to the Tenant by the utility company or the municipality).
In Burland Properties (footnote 5), the Supreme Court of Canada concluded that "
the amounts of the taxes paid by the respondent's tenant in pursuance of its covenant in the lease were payments similar to rent made for the use in Canada of property." Similarly, in LeCaine (footnote 6), the Tax Court of Canada stated that "[i]f a tenant pays an expense related to the property in lieu of paying rent, it seems to me that it is the same as paying rent to the landlord and should be accounted by the landlord in the same manner as if the rental cheque was written directly to the landlord." (footnote 7) Therefore, if the Tenant makes property tax payments on behalf of the Owner under the rental arrangement with the Owner, the amount paid by the Tenant would be subject to withholding tax under paragraph 212(1)(d). Similarly, if there are any other payments that the Tenant makes for and on behalf of the Owner that is attributable to the ownership of the Real Property rather than the occupation of property, such payments would also be considered rent or payments similar to rent and be subject to withholding tax under paragraph 212(1)(d).
The payments by the Tenant for the utilities would be of a different nature than the payments of property tax if they represent payments for services provided by the utilities companies and consumed by the Tenant (i.e., if the payments are dependent on the use of the utility). Payments of this nature would not be considered payments for the use of the Real Property but rather payments for the use of the services provided by the utility company. As such, they would not be subject to withholding tax under paragraph 212(1)(d).
Comparison to the taxation of rental income under Part I
In your email, you also raised a concern as to whether the treatment under Part XIII of the amounts paid by the Tenant in both scenarios above should be similar to the tax treatment of such amounts under Part I in a domestic context. In particular, you made a reference to the following section in Guide T4036, Rental Income:
Renting below fair market value
You can deduct your expenses only if you incur them to earn income. In certain cases, you may ask your son or daughter, or another relative living with you, to pay a small amount for the upkeep of your house or to cover the cost of groceries. You do not report this amount in your income, and you cannot claim rental expenses. This is, in fact, a cost-sharing arrangement, so you cannot claim a rental loss.
If you lose money because you rent a property to a person you know for less money than you would a person you don't know, you cannot claim a rental loss. When your rental expenses are consistently more than your rental income, you may not be allowed to claim a rental loss because your rental operation is not considered to be a source of income. However, you can claim a rental loss if you are renting the property to a relative for the same rate as you would charge other tenants and you reasonably expect to make a profit.
The above comments are based on the extensive case law that deals with the issue of rent being a source of income for purposes of Part I tax. In a number of cases (see, for example, Burnett, Landriault, Rapuano, Ziu, Daoust, Emond, Manning, Preiss) (footnote 8), rental losses were disallowed on the basis that there was no source of income.
The existence of a source of income in those cases was primarily determined based on the Supreme Court of Canada decision in Stewart (footnote 9), which stated as follows:
"It is undisputed that the concept of a "source of income" is fundamental to the Canadian tax system; however, any test which assesses the existence of a source must be firmly based on the words and scheme of the Act. As such, in order to determine whether a particular activity constitutes a source of income, the taxpayer must show that he or she intends to carry on that activity in pursuit of profit and support that intention with evidence
" (footnote 10)
Part I is structured in such a way that it applies to the taxable income of a taxpayer, which is computed based on the taxpayer's income. Income is computed under section 3 based on the sourcing principle (i.e., income for purposes of Part I tax includes income from various sources) and particular provisions of the Act provide detailed rules for computing such income from various sources. With respect to business and property income, for example, the basic computation rule is found in section 9, which effectively determines a taxpayer's income for a taxation year from a business or property as the taxpayer's profit therefrom for the year. As such, for purposes of Part I tax, a taxpayer must first determine if he or she has a source of income and then compute such income using the rules in Part I. Therefore, in the circumstances where rent does not represent a source of income (e.g., where below market rent is charged to a related person or where a related person is covering some of the expenses associated with the property in a cost sharing arrangement) no income need be reported and no expense may be claimed by the owner of the property (see, for example, LeCaine and Leisser (footnote 11)).
However, these comments are only relevant, in our view, for purposes of Part I. The tax regime of rental income for non-resident owners under Part XIII is different. The taxation of non-resident persons under Part XIII is not source-based but, rather, is payment-based. In other words, a non-resident does not have to have a source of income in order to be taxed on the payments or credits which such person receives from Canada. As a result, the comments in Guide T4036 do not apply to rent or similar payments (or credits) made to a non-resident person.
We hope our comments are of assistance to you.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency'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: LPRA-PLAR ITR-DDI Access Team-Équipe d'Accès. In such cases, a copy will be sent to you for delivery to the taxpayer.
Lori M. Carruthers CPA, CA
Income Tax Rulings Directorate
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 A tax treaty between Canada and the jurisdiction of the recipient of the payment could either reduce the tax rate or eliminate the taxation; however, most, if not all, of Canada's treaties allow Canada to tax income derived from the use of real property situated in Canada at the Canadian domestic tax rates (see, for example, Article VI of the Canada-U.S. Treaty).
2 The remainder of paragraph 212(1)(d) is not relevant for the purposes of this document.
3 There are certain definitions of "rent" in other provisions of the Act and in the Income Tax Regulations but they are of limited application and only provide inclusive definitions as opposed to actually defining the term "rent" (see, for example, subsection 122.1(1) and Regulation 1100(14.1)).
4 See, for example, Buonincontri v. The Queen (1985 DTC 5277 (FCTD)) and Canada v. Saint John Shipbuilding & Dry Dock Co. (80 D.T.C. 6272 (F.C.A.)).
5 MNR v. C.I. Burland Properties Ltd., 68 D.T.C. 5220.
6 LeCaine v The Queen, 2009 TCC 382.
7 Ibid, at paragraph 124.
8 Burnett v The Queen, 2009 TCC 430; Landriault et al v The Queen, 2009 TCC 378; Rapuano v The Queen, 2009 TCC 150; Ziu v The Queen, 2009 TCC 147; Daoust v The Queen, 2011 FCA 67; Emond v The Queen, 2011 TCC 142; Manning v The Queen, 2013 TCC 51; Preiss v The Queen, 2009 TCC 488.
9 Stewart v The Queen, 2002 DTC 6983.
10 Ibid, at para.5.
11 LeCaine v The Queen, 2009 TCC 382; Leisser v The Queen, 2011 TCC 472.
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