Canada: Amendments Would Remove Obstacle To Defeasance Transactions

Reprinted from Tax Notes Int’l, July 9, 2007, p. 130

Proposed amendments to the regulations to the Income Tax Act (Canada) were published on June 23, 2007, which, when enacted, will formally expand the scope of what validly constitutes a ‘‘qualified investment’’ for Canadian tax purposes.

As noted in the ‘‘Regulatory Impact Analysis Statement’’ that accompanied the release of the proposed amendments, the definition of a qualified investment will be ‘‘amended to ensure that a mortgage certificate will not lose its qualified investment status if a mortgage that was registered in connection with the certificate is released in exchange for the provision of other high- quality substitute security.’’ The new, expanded definition of a qualified investment is proposed to apply, with retroactive effect, after 2005.


Over the past decade, the size of the Canadian commercial mortgage-backed securities (CMBS) market has grown at a dramatic rate. It has been reported that more than $4.5 billion of Canadian CMBS were issued in 2006 alone.1

As the size of the Canadian CMBS market expanded, the prevalence of defeasance transactions also increased. In 2006, 37 loans, totalling more than $560 million, were defeased.2

In the context of securitized mortgage loans, in its simplest form, defeasance is the process by which a borrower replaces real property security in respect of a particular debt obligation with personal property security. The mortgage is discharged from the real property security, and the borrower is free to sell or refinance the property as it wishes. All obligations under the loan and the mortgage, other than those related to the use, operation, or ownership of the original real property security remain in place, such as the obligation to continue to make payments under the loan. In exchange for a release of its security interest in the real property, a mortgagee receives a pledge of bonds from the borrower. The bonds are generally high-quality, triple-A-rated, sovereign risk (such as government of Canada bonds) and are purchased in such a combination that the proceeds from the maturity and coupons of the bonds match the future payments that will be due under the loan. Thus, provided an efficient portfolio of bonds has been assembled, each future payment under the loan is matched to a bond within the portfolio that comes due, or pays a coupon, on or before a payment date such that the remaining payments under the loan are fully covered by the income stream from the bonds.

As a means of maximizing the marketability of particular CMBS offerings, some CMBS are structured so as to permit Canadian registered retirement savings plans, registered retirement income funds, deferred profit sharing plans, and registered education savings plans (collectively, registered plans) to validly acquire and hold the CMBS product without triggering harsh tax consequences.

The Tax Act generally provides that a registered plan may be subject to special Canadian tax liabilities if the plan holds property other than qualified investments. The regulations to the Tax Act have historically provided that a certificate evidencing an undivided interest in one or more properties constitutes a qualified investment where: (i) all or substantially all3 of the fair market value of the certificate is attributable to property that is, or is incidental to, a debt obligation secured by a mortgage, charge, hypothec, or similar instrument in respect of real property situated in Canada; (ii) the certificate has, at the time of its acquisition by the registered plan, an investment grade rating with a bond rating agency that rates debt in the ordinary course of its business (the bond rating test); and (iii) the certificate is issued as part of an issue of certificates by the issuer for a total amount of at least $25,000,000 (the offering test).

The documentation governing a CMBS offering will frequently provide that no defeasance transactions will be permitted to be undertaken if the defeasance will compromise the status of the CMBS as a qualified investment for Canadian tax purposes (a qualified investment limitation). Hence, to the extent that a borrower wished to undertake a defeasance transaction in respect of a CMBS that was encumbered by a qualified investment limitation, concerns would arise if the real property security being released had a fair market value in excess of 10 percent of the fair market value of all of the property used to secure the operative debt obligation. Such concerns were particularly acute when dealing with debt obligations that were secured by a small number of sizeable Canadian real properties.

At the end of August 2006, the Canadian Department of Finance was asked to expand the applicable definition of a qualified investment to capture CMBS that were initially secured by Canadian real property, yet were subsequently fully defeased by the pledging of debt obligations as replacement security. On August 30, 2006, the Department of Finance issued a comfort letter confirming that it would recommend to the Minister of Finance that the regulations to the Tax Act be amended to allow for bonds secured by Canadian real property to be fully defeased with high-quality debt instruments without jeopardizing the status of a CMBS as a qualified investment for Canadian tax purposes.

On the enactment of the proposed amendments, a certificate that satisfies the bond-rating test and the offering test will be a qualified investment provided all or substantially all of the fair market value of the certificate is attributable to property that is, or is incidental to, a debt obligation secured by either: (a) a mortgage, charge, hypothec, or similar instrument in respect of real or immoveable property situated in Canada; or (b) certain bonds, debentures, notes, mortgages, hypothecary claims, or similar obligations of the Canadian or a provincial government, including bonds guaranteed by the government of Canada, that were substituted for the security referred to in paragraph (a) under the terms of the debt obligation.

It is expected that the new, expanded definition of a qualified investment will remove a potential obstacle to defeasance transactions, particularly in respect of debt obligations that are secured against a small number of large pieces of Canadian real property.


1. Erin Stafford, ‘‘Canadian CMBS Industry Recap’’ (Canadian Mortgage Securities Association, May 9, 2007).

2. Id.

3. The Canada Revenue Agency generally asserts that the phrase ‘‘all or substantially all’’ represents 90 percent or more of a particular amount.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2007 McMillan Binch Mendelsohn LLP

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Stephanie M. Robinson
In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions