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Buying a Practice? Confirm that the Seller is a Canadian Resident or Else You’ll OWE $$$

By November 27, 2018November 5th, 2019Buying a Practice

We do lots of dental deals each year in Ontario.  And buried in the legal paperwork is this statement that the selling dentist or dentistry professional corporation IS NOT A NON-RESIDENT OF CANADA.  I know… it sounds backwards.  Why not just say that the seller IS a resident of Canada?  Because that’s not how our tax laws operate.  It’s a double negative and there’s lots of legalities around it (which I won’t bore you with).

But I will say this… typically, in the share purchase agreement and in the closing documents that are signed to “close” or complete the transaction, there’s a statement that the seller gives to the effect that they are NOT a NON-RESIDENT of Canada.  What’s the big deal about giving this statement you ask?

Well, for the Purchaser, it can be a big deal if it turns out that this statement IS NOT TRUE.  The reason being that section 116 of the Income Tax Act says that, where a purchasing dentist acquires from a NON-RESIDENT person any taxable Canadian property other than depreciable property (so this includes shares in a dentistry professional corporation), the Purchaser is LIABLE TO PAY TAX on behalf of the NON-RESIDENT Seller!

So why would that impact Ontario dentists buying from Ontario dentists?  Typically, it wouldn’t.  Because an Ontario dentist, one would presume, is a resident of Canada.  They live here.  They own a home here.  They have a family here.  They have a practice here.  There is an economical and social nexus between them and this beautiful country we call Canada.  And if the seller is a professional corporation, then we presume that the acting and controlling minds of that corporation – typically, again the dentist owner / operator – is a Canadian resident.  There are laws that require, for example, that at least 25% of the board of directors of a dentistry professional corporation must be resident Canadians (see section 118(3) of the Ontario Business Corporations Act).  And these laws apply to all dentistry professional corporations.

But there’s always that one-off case that MAY involve a non-resident seller – for example, if a dentist’s spouse, parent or child is a shareholder and is selling their shares.  And they were likely added as shareholders for tax benefits.  But they may not be residents of Canada.  So that’s where section 116 of the Income Tax Act may come into play and penalize the buyer.

Is there anyway around this?  Thankfully Yes!  Section 116 says that the Buyer won’t be liable for the tax of the non-resident seller if “after reasonable inquiry the purchaser had no reason to believe that the non-resident person was not resident in Canada”.

Ok so what constitutes reasonably inquiry?

Well, let’s look at the case of Kau v. The Queen, 2018 D.T.C. 1112.  In that case, a taxpayer (Mr.  Anibal Kau)  bought a Toronto condo unit from a non-resident of Canada.  As part of the deal, the seller gave a statement to Mr. Kau’s lawyer that the seller was not a non-resident of Canada.  All good, right?  Nope… A few additional facts:

  1. Mr. Kau did not personally make enquiry as to the residence of the seller.
  2. Mr. Kau’s lawyer knew that the seller’s address for service was an address in California (and he had seen that address 2 years earlier when he helped the seller buy that unit).
  3. Mr. Kau’s lawyer knew that the seller did not reside in the Toronto condo that he was selling.
  4. Mr. Kau’s lawyer had requested from the seller satisfactory compliance with section 116.  What he received in return was an UNSWORN Affidavit signed by the vendor with a declaration saying “I am not a non-resident of Canada within the meaning of section 116 of the Income Tax Act (Canada)”.
  5. Mr. Kau’s lawyer did not ask any follow up questions.
  6. The UNSWORN Affidavit was very problematic for the Court.  First, it wasn’t sworn before a commissioner for taking oaths in Canada (it was sworn before a California notary).  Second, it was “declared” and not “Sworn”.  “Declared” is what a document does when someone doesn’t want to swear on a Bible or other holy book.   But there was missing wording in the Declaration.  There wasn’t any statement that it was a SOLEMN DECLARATION and that was no indication that the declared statement was intended to have the same force and effect as if given under oath and or that it had been declared under penalty of perjury.
Given all of the above red flags (Mr. Kau’s lawyer’s knowledge and the Affidavit), the Tax Court of Canada held that the purchaser had not met the standard (either personally or through his lawyer) of conducting a “reasonable inquiry”.  On that basis, the purchaser was liable for $92k of taxes that was owed by the non-resident Canadian seller to the Canadian government.  Bummer!
Worth mentioning is that the court concluded that “reasonable inquiry” could include a range of actions or inactions, determined by the pertinent factual context.  Section 116 deserves more than a brief, baldly stated affidavit or solemn declaration when there are factual red-flags potentially suggestive of non-residency.
What’s interesting to note is whether the Mr. Kau would have any legal recourse to go after the seller for breach of a representation or warranty.  In other words: Mr. Kau is out of pocket $92k because of a statement the seller gave that turned out to be false.  Typically, a purchase and sale agreement would cover this as an “indemnity” or promise to pay.  But it wasn’t discussed by the Tax Court of Canada, which was only dealing with the issue of whether section 116 applied to punish Mr. Kau based on whether he had made a “reasonable inquiry” to confirm that the seller was not a non-resident of Canada.
The Content of this post is provided for informational purposes only. It is not intended to be legal, financial, tax, or other professional advice of any kind. You are advised to contact DMC (or other counsel) to seek specific legal advice concerning your individual situation.