Yiyun Chen and Winnie Szeto, Toronto
In this recent case, the Tax Court of Canada confirmed that a tenant was liable for Part XIII withholding tax on rents he paid even if he was not aware of the landlord’s nonresident status.
The taxpayer’s due diligence defence was ultimately unsuccessful, and the court ruled that the taxpayer was liable for the Part XIII tax assessed, in addition to interest and penalties.
Part XIII tax scheme
Generally, nonresident persons who earn income from property in Canada — such as rents, royalties, dividends and interest — that is not attributable to a business carried on in Canada through a permanent establishment are not subject to Part I tax under the Income Tax Act (the Act). Instead, they may be subject to Part XIII tax, which imposes a 25% withholding tax on such income, with a possible rate reduction under an applicable tax treaty between Canada and the nonresident's country of residence.1
To ensure proper collection of Part XIII tax, the onus is placed on payers to withhold and remit the appropriate tax amount when making payments subject to Part XIII. For instance, in the case of rental payments paid or credited to a nonresident, the payer, who could be the property manager or tenant, must usually withhold Part XIII tax at 25% of the gross rent at source.2
The payer must also report the gross rent and tax withheld on Form NR4, Statement of Amounts Paid or Credited to Non-Residents of Canada. If the payer fails to withhold and remit Part XIII tax to the Canada Revenue Agency (CRA), they remain liable for the tax and may recover the amount from other payments they are required to make to the nonresident.3
Facts
In 1996, Mr. X, a shareholder of Xco, the taxpayer, leased a residential rental unit in Québec from Aco. In 2006, the unit was sold to Ms. A, one of Aco’s shareholders. In 2010, Mr. X entered into a new lease agreement for the unit with Ms. A as the lessor. From July 2011 to January 2016, Xco paid rents to Ms. A on behalf of Mr. X and no Part XIII tax was withheld from these payments.
In 2018, the CRA assessed Xco, under subsections 215(1) and (6) of the Act, for failure to withhold and remit Part XIII tax on the rental income received by Ms. A for the 2011 to 2016 taxation years, as well as interest and penalties. The CRA’s basis for this assessment was that Ms. A was a nonresident during those years.
The taxpayer disagreed and appealed the assessments to the Tax Court of Canada.
Court’s analysis and decision
In this appeal, the court had to determine whether Xco paid rent to a nonresident person such that it is liable for the failure to withhold and remit Part XIII tax on the rental income. This can be further broken down into three separate questions:
- Was Ms. A a nonresident during the relevant taxation years?
- Was Xco liable for Part XIII tax if Mr. X was unaware that Ms. A was a nonresident?
- Was a due diligence defence available to Xco under the circumstances?
Determination of residency
At trial, Mr. X stated that he was never informed that Ms. A was living outside of Canada and cited evidence supporting her residency in Canada, such as a Canadian address on the deed of sale of the rental unit in 2006 and on the lease agreement in 2010, even though the agreement showed that Ms. A signed the agreement in Italy. Additionally, Ms. A had a social insurance number (SIN), a Canadian bank account and family in Canada.
However, the CRA disputed the reliability of the Canadian addresses as evidence that Ms. A lived in Canada and found no address linking Ms. A to Canada other than the rental unit. The CRA also discovered that Ms. A had a SIN, but she did not file any Canadian income tax returns or information returns.
Furthermore, the CRA reached Ms. A using an Italian phone number and Ms. A herself confirmed to the CRA that she resided in Italy. Indeed, Ms. A had sought judicial review of a decision by the CRA that denied her request for an extension of time to file under a provision of the Act that applied only to nonresidents.
The judge did not consider Ms. A’s Canadian addresses on the deed of sale or lease agreement, which were unsworn statements, to be definitive regarding her residency; the judge agreed with the CRA that the Canadian addresses were not conclusive of her residence.
After reviewing the evidence presented by both parties, the judge found that the list of factors pointing to Ms. A’s nonresidency was compelling, leading to the conclusion that she was a nonresident during the relevant years.
Knowledge requirement for Part XIII tax
The taxpayer further contended that it should only be liable for failure to withhold and remit Part XIII tax if it had knowledge that Ms. A was a nonresident; otherwise, it would be unfair and contrary to the legislative intent.
To support this argument, the taxpayer cited Curragh Inc. v The Queen, 94 DTC 1894, where the judge indicated that if a Canadian payer made payments to a Canadian agent without knowing that the beneficial owner was a nonresident, it would be difficult to see why the Canadian payer should be liable for failure to withhold and remit Part XIII tax under subsection 215(6).
However, the judge found that the decision in Curragh was inapplicable to the taxpayer’s case because the circumstances differed. In Curragh, the payment was made to a Canadian agent of the nonresident payee, and the payer in that case had knowledge that the payee was a nonresident. Additionally, the judge in Curragh did not directly address whether subsection 215(6) depended on the payer’s knowledge.
The court also reviewed the history of section 215, finding that no knowledge requirement existed when it was first introduced, and none had been added since. The court noted that if the legislators had intended to limit a resident's liability to cases where they had knowledge or belief, it would have expressly done so, as seen, for example, in subsection 116(5). Under this provision, a purchaser’s obligation to remit may be relieved if, after a “reasonable inquiry”, the purchaser had no reason to believe that the vendor was not a resident of Canada.
Due diligence defence
The taxpayer also sought to mount a due diligence defence, which is recognized by the courts with respect to some penalty provisions. However, the judge rejected this defence, citing J.K. Read Engineering Ltd. v The Queen, 2014 TCC 309, and stating that subsection 215(6) was not a penalty provision and the actual penalty provision was subsection 227(8).4
While a due diligence defence may have been available to Xco for subsection 227(8), the court found that the taxpayer failed to exercise a high degree of diligence by taking no steps to ensure compliance. Additionally, the taxpayer’s argument that it had no reason to believe Ms. A was a nonresident fell short of meeting the required high standard.
Ultimately, the court ruled that subsection 215(6) was devoid of any requirement that the payer must have knowledge that the payee was a nonresident. Therefore, the court agreed with the CRA that the taxpayer was liable for Part XIII tax under subsection 215(6) and was also responsible for penalties and interest under subsections 227(8) and (8.3).5
Lessons learned
As can be seen from the results of this case, the consequences of not complying with a Part XIII tax obligation can be harsh and there is little remedy available. Therefore, even though it might be challenging to determine a payee’s residency in some cases, a payer should always take active steps to verify. For example, payers should not rely solely on unsworn statements but must make inquiries of their own to determine a payee’s residency status. Even minor indicators suggesting nonresidency should prompt further inquiries and documentation. If it is determined that the payee is a nonresident, the payer should withhold and remit the proper amount of Part XIII tax based on the relevant income tax provisions and tax treaties.
Last, because 3792391 Canada Inc. is an informal procedure case, the results are not binding on the CRA or any other court, even where the facts are very similar. However, informal procedure decisions can offer informative lessons and they often have influential value for other judges.