What are the Section 116 requirements when an estate distributes cash from a sale of a real property to a US resident?
What are the Canadian income tax consequences arising from a proposed cash distribution by a Canadian estate to a non-resident beneficiary of an estate?
We recently researched the following issue.
Consider the following facts:
The beneficiary is a non-resident of Canada and a resident of the United States for purposes of the Treaty.
The beneficiary holds a capital interest in a Canadian estate.
The estate previously disposed of Canadian real property (its only asset), and the resulting gain was taxed in the estate’s 2024 taxation year.
Following the sale, the estate’s assets consist entirely of cash, including proceeds from the sale of the Canadian real property.
The estate proposes to distribute cash to the beneficiary in satisfaction of the beneficiary’s capital interest.
Analysis
Where an estate distributes property to a non-resident beneficiary in satisfaction of the beneficiary’s capital interest, the beneficiary is deemed to have disposed of that interest for Canadian tax purposes.
In this case, the beneficiary’s capital interest constitutes taxable Canadian property (“TCP”) under paragraph (d) of the definition in subsection 248(1) of the Income Tax Act (the “Act”), because more than 50% of its value was derived, at some point in the preceding 60 months, from Canadian real property.
Ordinarily, a disposition of TCP by a non-resident triggers the application of section 116 of the Act, which imposes notification, clearance certificate, and potential withholding tax obligations on both the non-resident vendor and the purchaser (here, the estate).
However, section 116 does not apply if the property disposed of qualifies as excluded property, including treaty-exempt property under paragraph 116(6)(i).
For property to be treaty-exempt under subsection 116(6.1), it must be treaty-protected property at the time of disposition.
Treaty-protected property is defined in subsection 248(1) as property any income or gain from the disposition of which would be exempt from Canadian tax under Part I of the Act by virtue of an applicable tax treaty.
The relevant provisions of the Canada–United States Income Tax Convention are found in Article XIII (Capital Gains).
Article XIII(1) permits Canada to tax gains from the alienation of real property situated in Canada.
Article XIII(3)(b)(iii) further provides that an interest in a trust is treated as Canadian real property only if, at the time of disposition, its value is derived principally from Canadian real property.
Unlike the Act, the Treaty does not contain a 60-month look-back rule; the analysis is performed strictly at the time of disposition.
Applying these principles to the present facts, the estate had already sold its only Canadian real property prior to the proposed distribution.
At the time of distribution, the estate’s assets consisted entirely of cash, even though that cash represents proceeds from the earlier sale of Canadian real property.
As a result, at the relevant time, the value of the beneficiary’s interest in the estate is not derived principally from Canadian real property for purposes of Article XIII(3)(b)(iii).
Accordingly, the beneficiary’s interest is not considered real property situated in Canada under the Treaty, and Canada does not have taxing rights over any gain arising on the deemed disposition of that interest under Article XIII(1).
The interest therefore qualifies as treaty-protected property, and consequently as treaty-exempt and excluded property for purposes of subsections 116(6) and 116(6.1) of the Act.
Although the clearance certificate and withholding tax requirements under section 116 do not apply, a statutory notification obligation remains.
Pursuant to paragraph 116(6)(i), the estate must notify the Canada Revenue Agency within 30 days of the distribution by filing Form T2062C – Notification of an Acquisition of Treaty-Protected Property from a Non-Resident Vendor.
In summary, while the beneficiary’s capital interest is technically TCP under the Act, treaty relief eliminates Canadian tax and withholding exposure under section 116, subject to timely CRA notification.