On July 20, 2011, the Minister of Finance announced proposed amendments to the Income Tax Act (Canada) (the ITA) relating to the taxation of SIFTs, REITs and publicly traded corporations (the Proposed Amendments). The main focus of the Proposed Amendments is to deny the tax benefits associated with certain publicly-traded stapled securities. The Proposed Amendments also address certain technical issues arising under the SIFT rules in the ITA.
Frustration of the SIFT Rules
When the SIFT rules were first announced on October 31, 2006, the Government of Canada (the Government) stated that, if structures were devised that frustrated the policy objectives of the SIFT rules, the Government would introduce new legislation aimed at such structures. In the Backgrounder released with the announcement of the Proposed Amendments, the Minister stated that recent transactions involving publicly-traded stapled securities frustrate the policy objectives of the SIFT rules. The Government is therefore introducing the Proposed Amendments in order to limit the deductibility of certain amounts payable in respect of publicly-traded stapled securities.
Stapled Securities Affected by the Proposed Amendments
"Stapled securities" are described in the Backgrounder as being two separate securities that are not freely transferable independently of each other. For this purpose, an unstapling of the securities that is made at the option of the investor or the issuer will be ignored unless the unstapling is permanent and irrevocable.
The Proposed Amendments will apply to stapled securities of an entity that are listed or traded on a stock exchange or other public market if any of the following applies:
- the stapled securities are both issued by the entity;
- one of the stapled securities is issued by the entity, and the other by a subsidiary of the entity; or
- one of the stapled securities is issued by a REIT or a subsidiary of a REIT.
A "subsidiary" of a particular entity is described in the Backgrounder as being an entity of which the particular entity, directly or indirectly, owns equity with a fair market value greater than 10% of the equity value of the entity.
The defined term "security" in the SIFT rules, which will presumably be the applicable defined term for the purposes of the Proposed Amendments, is quite broad and arguably could extend to contractual rights. Given that there is a broad range of financial instruments that may have contractual rights associated with them and given that such contractual rights would generally not be freely transferable independently from their associated financial instruments, it is possible that the Proposed Amendments could apply to financial instruments that are not intended to replicate features of income trusts. It is hoped that the draft legislation, when released, will be limited in scope to more closely focus on the apparent target of the Proposed Amendments, being stapled securities that frustrate the objective of the SIFT rules.
Consequences of the Application of the Proposed Amendments
In a circumstance where the stapled securities are issued by the same entity (or by an entity and a subsidiary of the entity) and one of those securities is debt in respect of which interest is payable, the Proposed Amendments will deny the deductibility of interest paid or payable under the debt. This aspect of the Proposed Amendments appears to be aimed at income funds that recently converted to corporations and that issued stapled debt and equity upon their conversion. Under the Proposed Amendments, such corporations will, after the transition period discussed below, no longer be permitted to deduct interest payable under such debt.
In a circumstance where the stapled securities consist of securities of a REIT and securities of another entity, the Proposed Amendments will deny the deductibility of payments made by the other entity to the REIT. This aspect of the Proposed Amendments appears to be aimed at structures under which business operations that could not be carried on by a REIT under the SIFT rules are owned by another entity and rental payments are made by such other entity to the REIT. The securities of the REIT and the other entity are stapled together, allowing investors to own an investment, and receive a return, that replicates the ownership of an investment in an entity that owns both the real property and operates the business. To the extent that the rental payments are deductible by the other entity, the taxable income of the other entity would be reduced, resulting in no entity level taxation on such amounts. The Proposed Amendments will, after the transition period described below, deny the deductibility of such rental payments, thereby resulting in entity level taxation on these amounts.
Effective Date and Transition Period
The Proposed Amendments are intended to apply to amounts paid or payable after July 20, 2011. However, entities with stapled securities that were issued and outstanding on July 19, 2011 will have until July 20, 2012 to restructure before the Proposed Amendments will become applicable to them, unless the stapled securities were issued and outstanding on October 31, 2006, in which case such entities will have until January 1, 2016 before the Proposed Amendments will apply.
Possibility of Future Amendments
In the Backgrounder, the Minister stated that the Government will continue to monitor structures and transactions that might frustrate the policy objectives of the SIFT rules and "will, as necessary, take appropriate corrective action".
Excluded Subsidiary Entity
While the SIFT rules are intended to apply to publicly-traded trusts and partnerships, the breadth of the rules is such that they could apply, in some circumstances, to entities the securities of which are not publicly-traded. The concept of an "excluded subsidiary entity", which is an entity to which the SIFT rules do not apply, was added to the SIFT rules in order to limit the circumstances in which privately owned entities could become subject to the SIFT rules.
Under the current SIFT rules, an entity will qualify as an excluded subsidiary entity if its equity is not listed or traded on a stock exchange or other public market and all of its equity is owned by taxable Canadian corporations, REITs, SIFTs and other excluded subsidiary entities. Under the Proposed Amendments, the category of persons that may hold equity of an excluded subsidiary entity is being expanded to include a person or partnership that does not have any security or right in the entity, including a right to acquire, directly or indirectly either:
- Any security of an entity that is listed or traded on a stock exchange or other public market; or
- Any property the amount, or fair market value, of which is determined primarily by reference to any security that is listed or traded on a stock exchange or other public market.
This Proposed Amendment will therefore allow individuals and entities that are exempt from tax under the ITA to own equity of privately held partnerships and trusts without causing such partnerships or trusts to become SIFTs, provided there is no right to acquire publicly listed securities or property deriving its fair market value therefrom, as described above. This Proposed Amendment will be deemed to have come into force on October 31, 2006, subject to the ability of an entity to elect to have this Proposed Amendment apply only for taxation years that begin after July 20, 2011.
Non-Portfolio Property of a Corporation
Publicly-traded trusts and partnerships will be SIFTs only if they own non-portfolio property. "Non-portfolio property" includes securities of certain subsidiaries, other than securities of "portfolio investment entities", which are entities that do not themselves own any "non-portfolio property".
The current wording of the SIFT rules could be interpreted to suggest that a corporation could be a portfolio investment entity even if it owns non-portfolio property. The Proposed Amendments will address this technical anomaly and clarify the SIFT rules to ensure that a corporation may qualify as a portfolio investment entity only if it does not own any non-portfolio property. This aspect of the Proposed Amendments will apply to taxation years that end after July 20, 2011.
The Proposed Amendments will require SIFTs to make payments of tax in accordance with the same monthly tax instalment regime that applies to corporations, rather than the quarterly instalment regime that currently applies to SIFTs. This aspect of the Proposed Amendments will apply to taxation years that begin after July 20, 2011.
Kimberly Wharram advises on tax issues associated with mergers and acquisitions, corporate reorganizations, mutual fund trusts and various other tax issues. Julie Colden practice includes tax aspects of corporate finance and capital markets, reorganizations and divestitures, mergers and acquisitions, and other corporate tax planning in the cross-border and domestic context. Judith Harris advises clients on income tax matters relating to domestic and foreign business ventures, acquisitions, corporate reorganizations and investment vehicles, with a particular emphasis on domestic and cross-border investment structures.
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