Buying an Ontario Business From a Non-Resident Seller: The Section 116 Holdback

You have found a business in Ontario and the owner lives outside Canada. Everything else about the deal may look routine, but the tax rules for non-resident sellers can leave you, the buyer, owing money to the Canada Revenue Agency (CRA) for a tax that is really the seller's.

That risk is why purchase agreements in these deals usually include a holdback. This article explains the main rules behind it, who has to do what, and what to raise with a lawyer and accountant before you sign. It does not cover indemnity caps or escrow terms, which are set by the contract.

Why the buyer is exposed

Section 116 of the Income Tax Act applies when a non-resident sells taxable Canadian property. A buyer of that property from a non-resident is liable to pay 25% of the amount by which its cost exceeds the certificate limit. The payment is due within 30 days after the end of the month of purchase, unless a certificate of compliance has been issued under s. 116(4).

In plain words, the law makes the buyer a safety net for the seller's Canadian tax. If the seller does not deal with the CRA, the buyer may have to pay. This is why agreements with non-resident sellers commonly provide for a holdback.

The holdback and the certificate of compliance

If no certificate of compliance is issued, the CRA says the buyer is entitled to withhold 25% of the proceeds, or 50% on certain types of property, less any certificate limit. Withholding lets you pay that amount to the CRA instead of paying it out of your own pocket.

The usual goal is for the seller to obtain a certificate before closing, so the full price can be paid to the seller. If the certificate is not ready, the agreement can let you hold back part of the price until it is. The exact amount, timing and release terms depend on the contract and on the type of property.

One more point to watch: the CRA may refuse a certificate of compliance if Underused Housing Tax obligations have not been met. Ask early whether any such obligations apply to the property involved.

What the non-resident seller must do

• Notify the Minister by registered mail no later than 10 days after the sale, unless a qualifying advance notice under s. 116(1) was already given.
• Expect a CRA penalty for late notice of $25 a day, with a minimum of $100 and a maximum of $2,500.
• Where a tax treaty fully exempts the gain on the sale, the seller generally does not need to notify the CRA.

Related buyers of treaty-protected property must file Form T2062C within 30 days of the purchase. Whether a treaty really protects a particular sale is a technical question for a tax professional.

Which shares are caught, and the residency representation

Shares of a corporation not listed on a designated stock exchange are taxable Canadian property if, at any time in the previous 60 months, more than 50% of their fair market value came from Canadian real property, resource property or timber resource property. Owning Ontario land or buildings does not by itself bring a share sale within the rules, because that more-than-50% value condition also has to be met.

There is also protection for careful buyers. Under s. 116(5), the buyer is not liable if, after reasonable inquiry, it had no reason to believe the seller was not resident in Canada.

• Ask the seller in writing where they are resident for tax purposes.
• Include a representation in the agreement stating clearly whether the seller is a resident of Canada, since the buyer's protection depends on having no reason to believe the seller was not resident.
• Keep records of the inquiries you made and the answers you received.
• Do not ignore signs that point the other way, such as a foreign address or foreign banking details.

What to do next

• Find out early whether the seller is a Canadian resident, and get that in writing.
• Ask whether the property sold could be taxable Canadian property, including shares that get their value from Canadian real property.
• Decide who will apply for the certificate of compliance, and when.
• Build the holdback into the agreement, including how and when it is released.
• Check whether any treaty exemption or Underused Housing Tax issue applies.
• Diarize the 10-day notice date and the 30-days-after-month-end payment date.

Because the exposure falls on you as buyer and the rules vary with the type of property, have a lawyer and an accountant review the structure before closing.

Frequently asked questions