June 21, 2020
By Felix Wu, Associate and Andy Yip, Articling Student, Farber Tax Law
Under Canada’s self-reporting tax system, taxpayers often assume that they are required to submit tax returns only when they earn income. However, it is important to note that unique circumstances may given rise to obligations in reporting and in tax even when an individual is a payer. This article will provide further information regarding the obligations arising from the unique situation where a non-resident has earned rental income from a Canadian property. Specifically, this article will discuss:
- an overview of the taxation of non-residents (i.e. Part XIII tax);
- the provisions regarding the reporting requirements and taxation of rental income earned by a non-resident (i.e. Section 212 of the ITA); and
- the opportunity to elect for unique tax treatment to be applied on the rental income (i.e. a Section 216 election).
Background: Part I vs. Part XIII Tax under the ITA
A non-resident may be required to pay either Part I or Part XIII tax under ITA, depending on the specific circumstances in which they have received their income.
In most cases, a non-resident person is taxed under subsection 212(1) of the ITA, which reads:
212(1) Every non-resident person shall pay an income tax of 25% 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… [Emphasis added].
As is listed further under section 212 of the ITA, the requirement to pay the 25% rate, known generally as Part XIII tax, applies where the amounts are of a passive nature – e.g. interest, dividend, rental or royalty income.
In the circumstance where a non-resident person is disposing a taxable Canadian property, or earning active business or employment income, they may also be subject to Part I tax under subsection 2(3) of the ITA, which enumerates three specific circumstances:
2(3) Where a person who is not taxable under subsection 2(1) for a taxation year
- was employed in Canada,
- carried on a business in Canada, or
- disposed of a taxable Canadian property,
at any time in the year or a previous year, an income tax shall be paid, as required by this Act, on the person’s taxable income earned in Canada for the year determined in accordance with Division D.
Reporting Requirements for Non-Resident Real-Estate Rental Income
The reporting requirement for a non-resident person earning rental income from a Canadian property will differ based on several important factors.
If a non-resident person is receiving the rental income as active business income, they will be subject to Part I tax requirements. Therefore, they will be required to file an income tax return as if they were a Canadian resident, and the income will be subject to the combined federal and provincial Part I tax rate on net rental income (i.e. revenue minus expenses).
Conversely, if a non-resident person has is receiving payments as part of passive rental income, they will be subject to Part XIII tax requirements, specifically under paragraph 212(1)(d) of the ITA. As opposed to a direct payment of tax to the Receiver General or Canada Revenue Agency (“CRA“), there is a withholding tax requirement which is generally satisfied by the Canadian resident payer (i.e. the tenant or lessee renting the property, or an agent of the non-resident payee).
Under paragraph 212(1)(d) of the ITA, the resident payer has the obligation to withhold 25% of the gross rental payment. Likewise, the resident payer is required to report the withholding tax to the CRA by preparing and filing a NR4 Statement of Amounts Paid or Credited to Non-Residents of Canada.
Who is liable for the tax?
Under subsection 227(8.1) of the ITA, the resident payer and non-resident payee are jointly and severally, or solidarily, liable for the principal tax as well as the interest accumulated. However, only the resident payer can be held liable for the penalty under subsection 227(8) for failure to remit withholding tax.
Note that under subsection 215(6) of the ITA, the resident payer may recover amounts that he or she failed to withhold but were paid to the non-resident payee.
Election under Section 216
The second option is to elect under section 216 of the ITA, which allows non-residents to calculate and pay their taxes based on their net rental income, after accounting for any expenses incurred in relation to the rental income (e.g. utilities, real estate agent commission, advertising fees…).
Electing under section 216 means that the non-resident will opt to pay his or her taxes under Part I of the ITA. In other words, section 216 election allows the non-resident’s rental income to be treated as a Canadian resident. The amount of tax will base on not only the non-resident’s net rental income, but also his or her marginal tax rate under the ITA. In other words, for the purposes of the rental income received in Canada, the non-resident will be treated as a Canadian resident for the calculation of his or her tax rate.
Ordinarily, section 216 elections must be submitted within two years after the end of taxation years, by filing a T1159 Income Tax Return for Electing Under Section 216 Form. Alternatively, a section 216 election can be done by asking the Canadian resident payer to file a NR6 Undertaking to File an Income Tax Return by a Non-Resident form for the CRA’s approval, before either:
- the first rental payment is due; or
- January 1st of each year.
When is it preferential to elect under section 216 rather than 212?
The main comparison between taxation under sections 212 and 216 of the ITA are with regard to the ability to deduct expenses and the taxation rates. Under subsection 212, a non-resident will pay Part XIII tax on the gross income amount. Conversely, subsection 216 allows a non-resident to be taxed on the net income amount accounting for expenses; however, they will be charged Part I tax. For these reasons, there are three main situations where it may be advantageous to elect under subsection 216 of the ITA:
- The non-resident has a relatively low marginal tax rate (i.e. they are in a lower tax bracket), as they will be charged Part I tax.
- The non-resident incurred substantial rental expenses which lead to a significant difference between the taxation on the gross and net rental income, and thus make it preferential to report the net amount.
- The non-resident comes from a country which has a higher withholding tax rate, based on that specific country’s tax treaty with Canada. This will impact the Part XIII tax that they would be charged under subsection 212.
Alternatively, if the non-resident’s rental income constituted active business income, section 216 election will not be available as they will be required to report the rental income under Part I, subsection 2(3) of the ITA.
While it is the resident payer’s obligation to withhold and remit Part XIII taxes, the resident’s failure to remit withholding taxes may lead to assessment on not only the resident payer, but also the non-resident payee. In order to correct the resident’s mistake, both the resident payer and the non-resident payee can correct their tax reporting under various mechanisms. However, due to the restraints under the Voluntary Disclosure Program, non-residents must be cautious in reporting the unreported rental income.
Ordinarily, the CRA allows taxpayers to file an application under the Voluntary Disclosure Program (“VDP”) to correct any mistakes or omission in their tax filing or remittances. If successful, an applicant under the VDP may get interest and penalty relief under the program. However, one of the criteria under the VDP is the application of penalty, which does not apply to non-resident landlords/renters when the resident payer failed to remit withholding tax under section 212. Subsection 227(8) of the ITA imposes penalties on the resident payer, and not on the non-resident payee, for the resident’s failure to remit the requisite withholding tax. Furthermore, the VDP specifically prohibits any type of election upon filing of the application, such as election under section 216 of the ITA.
In other words, while the resident payer may be qualified under the VDP, the non-resident payee will most likely be disqualified under the VDP. However, as the non-resident payee, there are two options available.
Option 1: Late filing under section 212
The non-resident can contact the CRA, register for a non-resident account number, and arrange payment of the outstanding withholding tax with the CRA. Please note that beside the principal tax amount, the non-resident payee will also be held jointly liable for the accrued interest under subsection 227(8.1) of the ITA.
As stated above, late filing under section 212 generally will not result in any penalties assessed against the non-resident payee. However, by disclosing the resident’s mistake, the CRA will likely assess the resident for failure to remit penalties under subsection 227(8) of the ITA.
Option 2: Late filing under section 216
The non-resident payee may also wish to elect under section 216, even an election was not made at the time. While a section 216 election generally has to be made within two years after the end of taxation year, a non-resident payee can make a late election only if certain criteria are met:
- The CRA has not advised the non-resident payee on his or her Part XIII tax (i.e. withholding tax) obligations;
- The CRA has not initiated action against the non-resident payee because of his or her failure to comply with Part XIII tax; and
- The CRA has not received or approved submission of Form NR6 – Undertaking to File an Income Tax Return by a Non-Resident Receiving Rent From Real Property or Receiving a Timber Royalty.
Keep in mind that even if the CRA approves the late election under section 216, the non-resident will still be held liable for the interest accumulated from the Part XIII tax. This view was reaffirmed in the Pechet v R. (2009 FCA 341) decision, where the Federal Court of Appeal confirmed that a successful 216 election does not absolve the non-resident of the interest accumulated under subsection 228(8.1). Instead, the successful election under section 216 merely replaced the non-resident’s Part XIII principal tax with Part I tax after the election was accepted.
Due to the complexity around withholding tax and its interaction with section 216 election, non-residents must be cautious when dealing with rental income generated in Canada. Likewise, Canadian tenants must also be cognizant of their withholding tax obligation when renting properties from non-residents.
This article is to be used for educational and non-commercial purposes only; the authors of this article do not intend the article to be a source of legal advice. Please retain and seek the advice of a lawyer and use your own good judgement before choosing to act on any information included in this article. If you choose to rely on the materials, you do so entirely at your own risk.
Canadian Tax Foundation, Part XIII – Tax & Traps,
Pechet v Canada, 2009 FCA 341 (CanLII), <http://canlii.ca/t/26p3s>.
Canada Revenue Agency, Subsection 216(1) Late-filing Policy, <https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/competent-authority-agreements-notices/subsection-216-1-late-filing-policy.html>.
Canada Revenue Agency, Income Tax Guide for Electing Under Section 216 – 2019,