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Non-Residents’ Taxation – Sale of Canadian Timber

Introduction

The topic of this article is the Canadian taxation of timber sold by a non-resident from a privately owned, non-commercial woodlot, who is not carrying on a business of selling timber.  In addition, the sales are not recurring transactions.  Typically, this is a person who owns land in Canada who is approached by a Canadian logging company wanting to purchase the timber (sometimes called stumpage) from that property.  Even though sold by a non-resident of Canada, this sale will be a taxable event to be reported to the Canadian government.  Depending on the terms of the timber sale, you, as the non-resident, may have two options on how to report the income for Canadian tax purposes.  In addition, there are a number or requirements and other decisions to be made to ensure you avoid penalties. If you have a sale of other Canadian real estate, see my article  Transfers of Canadian Real Estate Involving Non-Residents, for an overview of that taxation.  As you will see below, if the sale of timber does not qualify as a “timber royalty,” the tax filing procedures for timber are quite similar to other real estate sales.

My goal is to provide a simple overview for your understanding before you to proceed to the next step, which is likely dealing with a Canadian tax accountant to assist you, unless you are comfortable doing some additional research and handling the paperwork yourself.  I have done my best to interpret and explain these rules, but the rules are complex,  and for that reason, the Canada Revenue Agency (CRA) or other parties may interpret the rules differently.  I accept no liability for your conclusions based on this article, and advise you to seek professional tax advice in reaching your decisions.

Recommended preliminary reading for non-residents selling timber include CRA guide T4058, Non-Residents and Income Tax, as well as CRA Interpretation Bulletin IT-393R2, Election Re: Tax on Rents and Timber Royalties Non-Residents (Archived).

If you do not have a Canadian social insurance number, your first step prior to filing any tax forms will be to obtain a “tax identification number” if you do not already have one.  See Form T1261, Application for a Canada Revenue Agency Individual Tax Identification Number (ITN) for Non-Residents.

Remember that all amounts reported on Canadian tax forms are to be converted to Canadian dollars using the appropriate foreign exchange rate.

Two Types of Timber Sales

Sale of timber may be considered to be a sale of “Taxable Canadian Property”, which is treated the same as the sale of land in Canada. Alternatively, in certain situations, you have the option of treating the sale as a “timber royalty”.

Timber Royalty vs. Taxable Canadian Property

If the price you are paid for timber is “dependent on, or computed by reference to, the amount of timber cut or taken”, then the payment can be considered a “timber royalty.” This would be the case, for example, if you are approached by a contractor who is offering you X dollars per cord of wood, per board foot of timber, or per ton of wood harvested.  If they have already surveyed the property and are offering you the price based on their estimate of the volume of wood available, it will not be a timber royalty unless there are is an adjustment for the amount of timber actually cut or taken.  (For the technical research on this information, refer to Canada Revenue Agency document Number 2002-0173367  issued July 4, 2003 by the International Tax Directorate, including the appendix.)

If the price is not based on timber volume, it will not be a timber royalty, and will be a sale of Taxable Canadian Property.  You will be taxed under Part I of the Canadian Income Tax Act (ITA) under Section 2(3).

When does being a “timber royalty” mean for your taxation?  A timber royalty gives you a choice of being taxed under Part I or under Part XIII of the ITA.

What is the difference between Part I and Part XIII taxation?

Under Part I, the timber sale is treated as a capital gain under the category of Taxable Canadian Property, pursuant to subsection 2(3) of the Act, using an election under subsection 216(1) of the ITA.  Under Part XIII, the sale is treated as timber royalty income pursuant to paragraph 212(1)(e). The tax forms to be filed differ for each case.  An important point to note is that 100% of income is taxable, but only 50% of a capital gain is taxable (under current 2019 rules).

Point of Clarification for Your Own Research

When reviewing CRA literature and forms, please note that the tax rules also refer to “timber resource properties.” Taxation rules for sale of timber resource properties differ from timber royalties (or timber limits), and the distinction is difficult to understand, and hence, the categories are easily confused. This is an excerpt from CRA Interpretation Bulletin, IT-481, Timber Resource Property and Timber Limits:

A timber resource property is defined as a right or license to cut or remove timber from a limit or area in Canada (an “original right”) if that original right was acquired by the taxpayer after May 6, 1974 and, at the time of acquisition of the original right, the taxpayer may be reasonably regarded as having acquired, directly or indirectly, the right to

(a) extend or renew that original right, or

(b) acquire another such right or license in substitution therefor,

or the taxpayer may reasonably expect, at the time of acquisition of the original right, to be able to extend or renew that right or to acquire another right or license in substitution therefor in the normal course of events.

A one-time purchase of timber (or stumpage) from a non-commercial lot is the topic of this article, and would not be a timber resource property because the latter definition includes an ongoing or extendable right for harvesting.  However, it would be a timber limit (which is not specifically defined in the ITA)  See CRA Interpretation Bulleting IT-481 Timber Resource Property and Timber Limits (Archived).

Initial Documentation Requirements

The non-resident person selling the timber must send a notice to the Canada Revenue Agency (CRA) before or within 10 days after the sale.  Form T2062, Request for by a Non-Resident of Canada for a Certificate of Compliance, is used for timber limits being discussed in this article. This form will include a calculation of your gain from the sale (actual or proposed, depending on the timing of the request).  Together with the Request, you will be required to attach a 25% tax payment (or arrange to provide acceptable security for later payment).  The purchaser of your property will be responsible for your tax costs if you do not remit this payment.  After processing the Request, CRA will issue a certificate of compliance.

The Request may be filed at least 30 days prior to the transaction with estimated proceeds being reported.  The CRA will try to issue a certificate of compliance prior to the actual transaction date for the proposed transaction.  In this way, the transaction can occur without the purchaser having concerns about tax liability.  Alternatively, the Request may be filed within ten days after the sale.  If the ten day time limit is not met, there is a penalty of $25 per day, with a minimum of $100 and a maximum $2,500.  In such a case, the purchaser can be held liable for taxes of the vendor until the certificate is received.  For this reason, the purchaser often holds back a portion of the purchase price pending receipt of the certificate.  If your actual sales proceeds exceed the proposed amount you submitted to CRA, an additional payment is required.

Special Taxation Rules for Timber Royalties

As noted above, a non-resident has two options with respect to Canadian tax reporting of timber royalties – filing under Part I or Part XIII.  If you do not meet the definition of selling a timber royalty, then only the Part XIII option will apply to you.

Part XIII taxation – as Gains

Unless you elect otherwise, Part XIII will apply.  In this case, you should obtain the CRA Guide 5013-G and the tax forms to be completed; see Non-Residents and Deemed Residents of Canada Income Tax and Benefit Package .  Note that the Guide is extensive, and covers many situations.  The discussions on Electing under section 217 and 216.1 do not apply in this case.  For further clarification, the 216.1 election discussed in this Guide is not the same as a 216 election discussed below.  If you are not connected to an employer in Canada, and are not spending 183 days or more in Canada, it is very unlikely that the “deemed resident” or “deemed non-resident” rules relate to you, so much of the above Guide 5013-G will not be applicable to you.  You only need to refer to the information coded as “non-resident”.  The relevant forms if you only have a sale of timber will include the main Income Tax and Benefit Return, Schedule 3, Schedule A and Schedule B.  Briefly, Schedule 3 sets out your capital gains calculation, Schedule A determines your Canadian income and total world income, which is used on Schedule B to determine which tax credits can be deducted on the return to reduce your taxes.  Essentially, unless your Canadian income is 90% or more of your total world income (converted to Canadian dollars), you will receive very few, and not likely any, tax credits.

When reporting under Part XIII, you would be completing Schedule 3 of the tax return, to report capital gain on the sale.  The capital gain is your proceeds minus the cost of the property (timber) being sold, and minus your disposal costs such as legal fees.  The cost of your timber being sold is somewhat complex to determine, and I refer you to my article on Timber Sales and Taxes – Canadians Selling Trees from a Personal Woodlot for your interest.  Remember that the amounts claimed here as costs will impact the taxes on the future sale of your land also – you cannot use the same costs twice.  As noted above, professional tax advice should be considered.

With the Part XIII withholding tax of 25% as discussed above, no further Canadian tax return needs to be filed if  all of the following apply:

  1. the vendor is a non-resident at the time of the disposition;
  2. the vendor has no tax payable for the year pursuant to Part I of the Canadian Income Tax Act;
  3. the vendor does not owe any amounts under the Act for any prior year (other than amounts for which the CRA has accepted and holds adequate security); and
  4. all of the taxable Canadian property disposed of by the vendor is property for which the CRA has issued a certificate of compliance or is specifically “excluded property” under the Income Tax Act.

As discussed below, it is unlikely you will owe any taxes if the 25% withholding was remitted, and a return will not be required if the other three conditions have been met. However, as stated in CRA guide T4058, Non-Residents and Income Tax, you can file a return if you want to claim a refund.

Part I taxation – as Income (if so elected)o

You second option is to file a return under Part I of the Act.  To do this, you may elect under ITA subsection 216(1) to file a Canadian tax return using Form T1159, Income Tax Return for Electing Under Section 216.  By filing this form you are actually making the election and filing your tax return simultaneously.  Instructions are available in publication T4144, Income Tax Guide for Electing Under Section 216.  You have two years from the end of the year to file this return.  Interpretation Bulletin IT-393R2, Election Re: Tax on Rents and Timber Royalties Non-Residents (Archived) is particularly helpful in understanding this election.

This is actually quite a simple tax return to complete unless you plan to claim a deduction for capital cost allowance.  Briefly, capital cost allowance would be a deduction related to the cost of the timber on the property when you bought it.  Often, a deduction now will result in an equal or higher payment of taxes in the future when the property is sold, as long as you sell the property for more than you paid for it.  So, for a one time sale and because of the complexity, many taxpayers ignore it.

Which way to go

Should you file a Canadian tax return, and if your timber sale qualifies as a timber royalty, which type of return should you file?  First, if you owe taxes, you are required to file a return.  How do you know if you owe taxes without preparing one? Well, as noted in the next paragraph, it appears that a tax return would always generate a refund, so if you meet the other conditions explained above, a tax return is not required.

Current tax rates can be found on the EY website here under Canadian Personal Tax Rates – Non-Residents.  The lowest tax rate, which applies to income under $48,536 (in 2020), is 22.20%.  This would be 11.10% on a taxable capital gain because only 50% of a capital gain is taxable in Canada (for 2019, which may change in the future).  Under Part XIII (i.e. no election) this is a refund of 13.9% ($1,390 on each $10,000 of net proceeds within this tax bracket). In the worst case scenario, the highest tax rate on non-resident income begins at a taxable income threshold of $214,369 (for 2020), and is 48.84%.  This means that the highest rate on net proceeds from sale of timber reported under Part XIII as a capital gain would be 24.42%.  With 25% tax withheld, that means a refund of 0.58%, or a $580 refund for each $10,000 of net proceeds.

If you make the election to be taxed under Part I for a timber royalty, the income is fully taxable.  In the highest tax bracket, taxes would be owing, and a section 216(1) electionto use Part I would make no sense.  For the lowest bracket (under $48,536 in 2020), taxes would be at the rate of 22.20%, triggering a refund of 2.8% or $280 for each $10,000 of net proceeds.  Using 2020 rates, net proceeds of less than approximately $70,000 would provide a refund, but not as big as Part XIII.

However, there are additional considerations.  First, the Part XIII tax return is more complex to complete, and if you need help to do so, then the professional fees need to be considered.  Getting a small refund may not offset the tax return preparation fees.  Second, if you are also required to pay tax on the sale in your home country, you will likely get a foreign tax credit for Canadian taxes paid, at least up to the amount of your own country’s taxes on that same income.  Whether it is worth your time and cost to file a return depends on the net benefit after considering all of these factors.  Add together your home country tax cost minus its foreign tax credit plus the 25% Canadian withholding taxes.  Compare this to the recalculated figures after receiving a Canadian tax refund reduced by tax preparation costs.  How much better off will you be? Another factor to consider – will your home country allow you to claim a foreign tax credit if you do not file a Canadian tax return? In Canada, I met a taxpayer who had this experience with the CRA.  The CRA denied the foreign tax credit until a U.S.A. return was filed for sale of U.S. A. property.  Effectively, the CRA was saying that they were not going to give a larger tax credit than necessary if a refund was available from the U.S.A. government.

My conclusion?  I think you should normally file a Canadian tax return.  If your timber sales are of a minor amount, and qualifies for the timber royalty election, then that option is easy and if you can do the simple form yourself, it is likely a good option for small sales.  Otherwise, filing the regular Part XIII tax return will likely save you the most money.  And remember to claim the foreign tax credit on your home country’s return.

A comment on International Tax Agreements

International tax treaties govern how the taxation works in situations such as this.  For the U.S.A., the Convention Between Canada and the United States of America with Respect to Taxes on Income and Capital applies.  Article VI (Income from Real Property) relates to the first scenario for timber royalties, and XIII (Gains) governs other timber and other property sales.  This treaty states that Canada has the right to assess taxes on timber sales, and gives rise to the above noted withholding taxes.  In most income situations, the country of residence has first right to charge taxes.  However, if the real estate is located in another country, that foreign country has limited ability to collect taxes on any real estate gains.  For example, consider how difficult it would be for Canada to place a legal claim for tax collection against someone living somewhere in the U.S.A.? Hence, imposing a non-resident withholding tax and placing a requirement on the seller to collect it avoids that problem.  Through international tax agreements, the home country of the taxpayer recognizes their resident’s tax obligation to the foreign country by offering a reduction in their own tax liability through granting of a foreign tax credit to the taxpayer.

Conclusion

The rules are complex, but now you have some idea on the issues.  Bottom line is that you must pay 25% tax upfront, and you are likely not required to file a Canadian tax return.  However, you are still entitled to file one if you are eligible for a refund, which will usually be the case.  You may have two choices on which return to file.  Making the subsection 216(1) election as a timber royalty, if eligible, results in a simpler tax return, but lower refund.

These are my thoughts, and if you, or your professional adviser, see an error in my interpretations, an email from via Contact page will be very much appreciated… as will any comments on this article.  Remember, this has been my best attempt at setting out the rules, but I accept no liability for its content and you should work with your own advisers.

 

Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum