Recent announcement clarifies grandfathering rules for Canadian income trusts.
On Friday December 15, the Department of Finance provided some clarification of the grandfathering rules affecting the recently proposed tax measures for Canadian income trusts.
The proposals, which were announced on October 31, 2006, would tax certain income trusts and other "specified investment flow-throughs" at corporate tax rates in respect of certain distributions made to unitholders. This new tax is to apply as of 2007 to new entities, but is deferred until 2011 for SIFTs that were publicly traded as of October 31, 2006. However, in the original materials released with the October 31 announcement, the Minister of Finance indicated that the "undue expansion" of an existing SIFT may result in the SIFT losing the benefit of the four-year deferral, while also noting that the continuation of the "normal growth" of a SIFT would not raise such concerns.
In a short release, the Department of Finance has now provided guidance as to what constitutes normal growth of a SIFT. Generally, in any of the periods set out below a SIFT will be entitled to grow by an amount that does not exceed the greater of $50 million and a prescribed "safe harbour." The safe harbour will be measured by reference to a SIFT’s market capitalization on October 31, 2006. For the period from November 1, 2006 to the end of 2007, a SIFT’s safe harbour will be 40% of the October 31, 2006 capitalization, and for each calendar year from 2008 through 2010 , the safe harbour will be 20% of that capitalization. Overall, a SIFT will be entitled to grow up to 100% over the four-year transition period. These safe harbours are cumulative, so the growth can be deferred but it cannot be accelerated.
Market capitalization on October 31, 2006 will be measured in terms of the value of a SIFT’s issued and outstanding publicly traded units. Market capitalization would not include any outstanding debt (even if the debt is convertible into units), options or other interests that were convertible into units of the SIFT. For example, a retained interest in the form of shares of a corporation or units of a partnership that are exchangeable for units of the SIFT trust would not be included in the market capitalization calculation.
For these purposes, any new equity issued by the SIFT would be considered growth and would include units and debt that is convertible into units. On the other hand, non-convertible debt would not count towards the safe harbour. However, if the new debt were replaced with equity, that equity would be counted as growth. Equity issued in satisfaction of the exercise by a person of a right in place on October 31, 2006 to exchange an interest in a partnership or a share of a corporation into new equity, or to replace debt outstanding on October 31, 2006 with new equity, will not be counted as growth for these purposes. Finally, the merger of two or more SIFTs, each of which was publicly traded on October 31, 2006, or a reorganization of such a SIFT, will not be considered growth provided there is no new net addition to equity as a result of the merger or reorganization.
In addition to providing these guidelines with respect to normal growth, the Department of Finance also stated that it is intended that conversions of a SIFT to a corporation will be allowed to take place without any tax consequences to investors on the conversion. If impediments to conversions exist under the current income tax rules, the Department of Finance stated that it will recommend changes to ensure that new provisions are in place to facilitate such conversions.
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