Canada: Proposed Income Trust Conversion Rules

On July 14, 2008, following up on a promise made on December 15, 2006, the Department of Finance released draft legislation to amend the Income Tax Act (Canada) (the "ITA") to facilitate the conversion of income trusts to public corporations (the "Proposals"). On October 31, 2006, the Minister of Finance had announced that, as of 2007, income trusts would essentially be taxed on their income, even if it was distributed to unitholders, at a rate similar to the rate applicable to corporations. Income trusts that were publicly traded as at October 31, 2006 will only be subject to these specified investment flow through ("SIFT") taxes after 2010, provided that certain restrictions relating to the expansion of the trust are respected – restrictions which may prove problematic for many income trusts.

The Proposals, if enacted, will enable publicly traded trusts that would otherwise have been subject to SIFT taxes to convert to corporate form in a tax-efficient manner. While income trusts are not required under the Proposals to convert immediately and income trusts that choose not to convert may still only be subject to SIFT taxes in 2011, many income trusts may nevertheless choose to convert immediately in order to avoid restrictions on growth currently imposed on them. The Proposals should therefore assist existing income trusts in the proactive pursuit of their business plans and enable them and the financial community to make medium to long term investment decisions as the transition period comes to a close at the end of 2010.

The Proposals should also allow acquisitions of income trusts by corporations to occur in a more straightforward and simple manner than is currently possible under existing legislation, where significant planning is required in order to ensure that, on the post-acquisition wind-up of the income trust structure, offsetting gains and losses are realized at the income trust and unitholder levels.

According to the Proposals, the conversion rules will apply to conversions that occur starting on July 14, 2008 until December 31, 2012 inclusively. No further tax-deferred conversions will be permitted after that date. As further described below, these rules may also be applicable on an elective basis for conversions which took place after December 19, 2007 and before July 14, 2008.

Rather than implementing a complex, stand-alone regime for the conversions, the Department of Finance has taken a more direct and simplified approach, which includes incorporating certain existing rules applicable in the context of corporate liquidations. The Proposals allow an income trust to convert into a corporation through one of two methods. The first method, referred to as the "Exchange Method", involves a two-step transaction whereby unitholders exchange all of their units for shares of a corporation, followed by a liquidation of the income trust into the corporation, the whole on a taxdeferred basis. The second method, referred to as the "Distribution Method", is limited to those structures in which the business is carried on through an underlying corporation, and involves a taxdeferred distribution to unitholders of the shares of that corporation. The most suitable method will depend largely on the particular income trust's current structure and tax attributes at the time of conversion.

The Proposals also address various other consequences of winding up an income trust structure, including rules dealing with acquisition of control, debt forgiveness and preservation of trust tax attributes.


Under the Exchange Method, unitholders may exchange their trust units for shares of a corporation, pursuant to rules similar to those governing share-for-share exchange under the ITA. This method provides an automatic tax-deferred rollover if the following conditions are met:

  • The corporation is a taxable Canadian corporation;

  • During a 60-day period before 2013, all of the units of the income trust are either disposed of to the corporation or redeemed or cancelled by the income trust;

  • Unitholders only receive shares as consideration for their income trust units and those shares must be of a single class (i.e., no cash or other non-share consideration); and

  • The fair market value of the shares received is equal to the fair market value of the trust units exchanged immediately before the disposition (for this reason, a newly formed corporation without other assets, liabilities or shareholders will be preferable).

The rollover under this method applies automatically, without the need to file an election, to exchanges of trust units satisfying these conditions and occurring on or after July 14, 2008 and before January 1, 2013. It is also available on an elective basis for exchanges which satisfied the above conditions and which took place after December 19, 2007 and before July 14, 2008. Such election may be made by the corporation unilaterally unless the corporation and the unitholder have made a valid election in respect of the exchange under subsection 85(1) or 85(2) of the ITA, in which case the election must be made jointly.

Certain aspects of the above conditions may prove difficult in practice. For example, an income trust may have multiple classes of units, each with different rights, entitlements and values, making it undesirable to exchange units of all classes for one single class of shares. The requirement that the fair market value of trust units and the shares for which they are exchanged be equal may also create uncertainty as it is unclear how such values will be determined. A requirement to respect proportionate interests might have been more manageable. Finally, unlike many of the other rollovers in the ITA, there is no opportunity to opt out of the automatic tax-deferred exchange. This will deprive income trust unitholders of the option to realize a capital gain on the exchange, which can sometimes be advantageous for personal tax planning reasons.

Once all unitholders have exchanged all of their income trust units for shares, the trust must liquidate and distribute its property to the corporation. This may be achieved on a tax-deferred basis in one of two ways.

The first way to liquidate the income trust is based on the rules in the ITA that normally apply to the liquidation of a wholly-owned Canadian corporation into its Canadian corporate parent (the "Corporate Wind-up Alternative"). The Corporate Wind-up Alternative is also available to the second-tier trust in a two-tier trust structure. The trust may distribute its property to the corporation (or to the income trust in the case of the second-tier trust in a two-tier trust structure) on a tax-deferred basis and benefit from the corporate liquidation rules if the following conditions are satisfied:

  • The distribution of all trust property takes place before 2013 and, if in the context of a two-tier trust structure, within 60 days of the first distribution of property by the second-tier trust;

  • Where the property distributed consists of shares of a taxable Canadian corporation, the trust has not acquired the shares of the corporation under the Trust Wind-up Alternative described below (i.e., in a two-tier trust structure where the second-tier trust has used the Trust Wind-up Alternative to distribute the shares to the income trust); and

  • The trust makes an election to have the Corporate Wind-up Alternative apply to the distribution.

An important feature of the Corporate Wind-up Alternative is that the tax attributes of the income trust (and of the second-tier trust in a two-tier trust structure), such as loss carry-forwards and tax credit pools, would flow through to the parent corporation in the same manner as in the case of a wind-up of a wholly-owned subsidiary.

The second way to wind up the income trust on a tax-deferred basis, after the exchange of all units for shares of a corporation as described above, is to make a tax-deferred transfer of the property of the income trust to the corporation which has become the sole unitholder (the "Trust Wind-up Alternative"). This alternative will only apply if the trust has not elected to apply the Corporate Wind-up Alternative and if the property of the income trust consists exclusively of shares of a taxable Canadian corporation. In addition, in the context of a two-tier trust structure, as in the case of the Corporate Wind-up Alternative, the distribution of property by the income trust must occur within 60 days of the first distribution of property by the second-tier trust. Under this alternative, the trust's tax attributes will not flow through to the parent corporation.

The Proposals also include a rule to address the settlement of inter-trust debt on the wind-up of the second-tier trust. Essentially, the same rule applies as for the liquidation of a wholly-owned taxable Canadian corporation which is indebted to its parent – on an elective basis and subject to respecting certain conditions, the debt is deemed to have been settled for an amount equal to its adjusted cost base to the parent.


The Distribution Method will only apply to income trust structures in which the trust is the parent of an underlying corporation. In order for this method to apply, the trust's only property must be shares of a corporation. Therefore, income trusts that hold debt or partnership interests will have to take additional steps to reorganize before using this method. Income trusts that have third-party debt will also have to take steps to reorganize their affairs before using this method.

Under this method, an income trust may distribute the shares (and only the shares) it holds to its unitholders on a tax-deferred basis if the following conditions are met:

  • The shares being distributed are shares of a taxable Canadian corporation;

  • All distributions occur before 2013 and, in the context of a two-tier trust structure, the distribution of property by the income trust occurs within 60 days of the first distribution of property by the second-tier trust; and

  • Unitholders dispose of all their interests as beneficiaries under the trust.

The Distribution Method is not elective. While this method may be simpler to implement than the Exchange Method, it has a number of limitations, including the fact that the tax attributes of the trust, such as loss carry-forwards and tax credit pools, are not preserved. Furthermore, as noted above, preliminary steps to reorganize the structure may be required, such as the conversion of an underlying partnership into a corporation or the capitalization of internal corporate debt.

Similar rules apply to the second-tier trust in a two-tier trust structure, where an income trust is the sole beneficiary of another trust that holds property, such as shares of a corporation. If the above conditions are met, the second trust may distribute its property and be wound up on a tax-deferred basis in the manner described above.

The rule addressing the settlement of inter-trust debt discussed above in the context of the Exchange Method also applies to the Distribution Method.


There are a number of issues that should be considered in deciding which of the Exchange Method or the Distribution Method is more suitable. Each structure will have to be assessed based on its own facts and circumstances, including any applicable legislative or contractual constraints.

  • The Proposals do not address the impact of the loss of "Canadian-controlled private corporation" status for any underlying corporations and no relief is provided from the effects of such a change of status, such as the deemed year-end on change of status.

  • The Proposals provide that, in the context of a two-tier trust structure, acquisition of control of the underlying corporation will be deemed not to have occurred as a result of the wind-up of the second-tier trust. However, the Proposals do not specify whether the wind-up of the income trust into the public corporation under the Exchange Method could result in an acquisition of control.

  • The potential liability of non-resident unitholders for non-resident withholding tax or income tax on trust distributions (under Part XIII or Part XIII.2 of the ITA) does not appear to be an issue under the Exchange Method. However, in the context of the Distribution Method, where there is actually a distribution of property by the income trust to the unitholders, the Proposals do not clearly provide that non-residents will not be so liable.

  • While the Exchange Method and the Distribution Method provide tax-deferred treatment for Canadian tax purposes, either may have different foreign tax consequences. Depending on the make-up of the unitholders, it may be desirable to consider what steps can be taken to obtain the best tax result in a particular foreign jurisdiction.

  • While the rules deal with potential debt forgiveness and capital gains/losses on the settlement of inter-trust debt, they do not deal with the potential for debt forgiveness where debt owing by the underlying corporation to the income trust (or the second-tier trust in a two-tier trust structure) is capitalized in order to use the Distribution Method described above. This may effectively force income trusts to use the Exchange Method in such circumstances.

  • Other legal considerations will include prospectus filing requirements, the ability to force unitholders to convert, restrictions imposed by any external debt, conversion features of existing debt, exchange rights of holders of minority interests in any underlying corporation or partnership, as well as the impact on employee benefit plans.

It is important to note that the Proposals are in draft form and changes should be expected. The Department of Finance has requested feedback on the Proposals and submissions should be forthcoming. Ogilvy Renault intends to make submissions on the above-noted issues and on technical matters that arise as these conversion rules are put into practice.

About Ogilvy Renault

Ogilvy Renault LLP is a full-service law firm with close to 450 lawyers and patent and trade-mark agents practicing in the areas of business, litigation, intellectual property, and employment and labour. Ogilvy Renault has offices in Montréal, Ottawa, Québec, Toronto, and London (England), and serves some of the largest and most successful corporations in Canada and in more than 120 countries worldwide. Find out more at

Ogilvy Renault is the International Legal Alliance's Canadian Gold Award winner for 2008 in M&A and Corporate Finance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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