When Bank of Montreal and Bank of Nova Scotia, two of Canada’s largest banks, recently announced the introduction of new or revised mortgage lending rules for foreigners and international students, many across the country hailed the decision.
Those sentiments were strongest in cities such as Vancouver and Toronto, where foreign buyers have been blamed at least in part for skyrocketing home values that have seen average single-family housing prices soar past $1 million in recent years.
Until now, Bank of Nova Scotia had waived income verification and mortgage repayment tests for foreign buyers with a 50 per cent down payment. Financing, in those cases, would be automatically approved.
Now, both lenders will require proof of income as part of their mortgage application process, mirroring many of the requirements set out for domestic mortgage applicants. The move was designed to even the playing field by targeting wealthy foreign investors who see Canada’s residential housing market as a safe haven for their investable assets.
This week, the federal Liberals announced plans to heighten enforcement of compliance measures already restricting non-residents from claiming the principal residence exemption (PRE) for years they are not resident in Canada. Under the rules, foreign buyers that were not resident in the year of purchase will not be able to claim the PRE on that home. Whether they would be entitled to the exemption should they eventually establish residency remains to be seen.
Other changes involve heightened reporting requirements. In the past, as long as there wasn’t a taxable gain on the sale of a permanent residence, the CRA didn’t require the disclosure of the disposition of the home with the corresponding PRE deduction. It would appear that now, under the rules, filing a form disclosing that disposition with the taxpayer’s tax return for the year of the sale will be mandatory.
The moves come on the heel of reports indicating that Finance Minister Bill Morneau has been carefully analyzing the domestic housing market and looking for ways to tighten restrictions on offshore investment.
And the federal government isn’t the only one paying close attention to this hot-button issue. British Columbia recently imposed a 15 per cent foreign home buyer tax to discourage overseas investors from speculating on Canadian property and, at least in theory, further inflating home values.
Indeed, the federal and provincial governments, as well as the banks, are responding to increasing pressure to cool Canada’s overheated housing market by doing something—anything—to slow the flow of foreign investment in the sector. But measures such as these are creating more questions than answers.
First, what constitutes proof of income when the foreign jurisdiction in question doesn’t have the same taxation system, compliance regimen or reporting rules as Canada? What happens when that foreign tax authority does not require the filing of an annual personal income tax return? Would an employment letter be sufficient evidence of income? How would a bank verify the statement’s authenticity?
Factor in the relatively lax reporting requirements when operating a business in many foreign jurisdictions, and the situation becomes even less clear.
That’s because, in many instances, foreign entrepreneurs may show little or no income on payroll and official tax records. Would financial statements and proof of legal business ownership be sufficient to prove income? If so, determining authenticity once again becomes a challenge. An equally important question: do banks have the capacity, network and resources to verify this information, or would they be forced to simply take the word of mortgage applicants? Currently, the banks have yet to detail a plan to implement these new income-verification requirements.
Not surprisingly, these moves create significant growth opportunities for domestic private lenders. While the cost of borrowing money from a private lender is relatively expensive when compared to traditional banks, it’s still far cheaper than borrowing from overseas banks, such as those in China. The benefits of domestic private borrowing become even more apparent when considering the cost of wiring funds overseas.
Ultimately, the most pressing question for governments is whether the measures will work. The root cause of widespread investment from markets such as China is the gaping real estate value gap—even for wealthy Chinese, home ownership is extraordinarily expensive in their home country when compared to the Canadian market’s relative affordability—along with the relative stability of the loonie in the face of a potential devaluation of China’s currency. Add in other mitigating factors such as the potential for political uncertainty or government crackdowns at home, and it’s easy to see why foreign investors, such as those from Russia, the Middle east and mainland China are seeking safe haven for their money.
Now, they also face increased Canadian government scrutiny and potential reporting and filing headaches.
Time will tell if they believe the added compliance costs and stress are worth the hassle of investing in Canadian property—and whether our red-hot market will cool off as a result.
Jenny Lian, Partner