In Canada, purchasers of a property pay a 25 per cent capital gains tax charged by the Canada Revenue Agency ("CRA") to a non-resident seller on any profit made on the sale based on section 116 of the Income Tax Act (Canada) ("ITA"). However, upon making a "reasonable inquiry," if the purchaser has no reason to believe that the seller was a non-resident, the purchaser is not liable to pay the tax.
In the recent and notable British Columbia Supreme Court decision, Mao v. Liu (2017 BCSC 226), Justice Affleck found the defendant, a notary public, liable to pay $695,000 to his clients, the plaintiffs and purchasers of a property, when the notary public failed to make a "reasonable inquiry" on the residency status of the seller.
The defendant's liability was founded on a breach of his contractual duty to fulfill an undertaking related to section 116 of the ITA, pursuant to the engagement letter between himself and the plaintiffs.
In the case at hand, the plaintiffs entered into a contract to purchase real property from a creditor of the property owners, pursuant to a court-ordered conduct of sale. The plaintiffs retained the defendant to complete conveyance of title to them, and to also make inquiries as to the residency of the seller, as required under section 116 of the ITA.
In attempting to discern whether the registered owners of the property were in fact Canadian residents, the defendant endeavoured to have a statutory declaration signed by the creditor to that effect. However, the creditors refused to sign such a declaration. After the sale had completed, it was revealed that one of the registered property owners was not a Canadian resident, and CRA demanded that the plaintiff purchasers pay the $695,000 tax applicable to the sale by a non-resident seller. The plaintiffs subsequently sued the defendant, claiming that he was liable to pay such amounts for failing to make "reasonable inquiry".
Justice Affleck found that by agreeing to undertake the inquiry as to the residency status of the property owners, the liability normally imposed on the purchaser for failing to make such reasonable inquiry was transferred to the defendant. It was clear to Justice Affleck that the inquiries that the defendant did make, were not "reasonable" as required by section 116. The evidence also revealed that the defendant failed to advise the plaintiffs of their potential tax liability before completion of the sale.
The holding in Mao v. Liu, begs the question: what constitutes "reasonable inquiry" under section 116 in order to avoid liability. Justice Affleck provides insight into the avoidance of such liability, by setting out what does not amount to a "reasonable inquiry". At paragraphs 9 and 12, the decision clearly lays out certain "indicia" that cannot be relied on when determining the residential status of the vendor, such as:
- notes to a statement of adjustment including a certification that the vendor is or will be a Canadian resident within the meaning of the ITA at the time of the sale; or
- title searches revealing that:
- the mailing address of the registered property owner(s) is a Canadian address;
- the registered property owner has owned the property for several years; and
- there is a history of mortgages against the property in favour of Canadian financial institutions.
Justice Affleck rejected the defendant's claim that the above information could be relied upon to indicate the registered owners were residents of Canada. Instead, Justice Affleck held that, absent a statutory declaration, further steps were required in order to make the "reasonable inquiry" required under section 116.
Though Justice Affleck did not expand on what these further steps entail, he did provide guidance on what a purchaser could do to avoid liability where a statutory declaration is not obtainable. At paragraph 25 it is recommended that a purchaser should deduct the applicable sum of money that would be taxed on completion of the sale from the purchase price. This deduction not only protects a purchaser from being personally liable to pay any tax required by the ITA, where the seller is found to non-Canadian resident, but it also allows a purchaser to complete the sale without being in breach of the purchase and sale contract.
The decision of Mao v. Liu depicts a cautionary tale for notaries and solicitors alike by providing insight as to the extent of liability imposed on those who undertake to make inquiries related to the residency status of a vendor, on behalf of a purchaser. This case makes clear that not only is it prudent practice, as a solicitor, to have a vendor execute a statutory declaration regarding residency, but that it should become a required precondition to closing. Where such a statutory declaration is not furnished to the purchaser, it is appropriate as noted by Justice Affleck, for the purchaser solicitor to advise that a holdback be taken in the amount to be taxed by section 116, in the sale at issue. Though this case has been appealed, as of now, this case also makes clear that where a purchaser's solicitor may have previously found comfort in certifications of residency in the notes to a statement of adjustment, such comfort is ill-founded.
It is foreseeable that Mao v. Liu, as it stands now, will impact the practical realities of how deals involving real property are structured - not only at the later stages of a deal - but also at the initial engagement letter stage. It is imperative for those acting on behalf of purchasers to get their house in order, including understanding the obligations imposed upon them by the ITA and to ensure that the purchasers they act for are also aware of the risks involved.