As promised the Department of Finance (Canada)
("Finance"), on July 14, 2008, released its draft
technical amendments (the "Conversion Rules") to the
Income Tax Act (Canada) (the "Tax Act") which are
designed to allow, where certain requirements are met, publicly
traded income trusts, known as SIFT trusts (as well as publicly
traded limited partnerships, known as SIFT partnerships) to
convert to taxable Canadian corporations on a tax-deferred
Taxation of Publicly Traded Income
On October 31, 2006, the Department of Finance (Canada)
announced its plan to tax SIFT trusts (and SIFT partnerships)
as corporations. While this announcement effectively put an end
to the creation of new SIFT trusts as well as the conversion of
publicly traded corporations into SIFT trusts, it also raised
the question of how existing SIFT trusts would be permitted to
be converted back into corporate form without drastic negative
tax consequences. Many of these SIFT trusts had incurred
substantial tax costs on their initial conversions from
corporations and to be taxed again on their conversion back
into corporations was seen as unnecessarily punitive. In
response to this concern, Finance agreed to devise a scheme
whereby these SIFT trusts could convert to corporations in a
tax-free or tax-deferred manner. The draft technical amendments
from July 14, 2008, or the Conversion Rules, are designed to do
Under the Conversion Rules, unitholders (both in SIFT trusts
and SIFT partnerships) will be entitled to transfer their units
to a taxable Canadian corporation on a tax-deferred basis in
exchange for shares of a that corporation. All of the shares of
the corporation issued as a part of this exchange must be of
the same class of shares. Additionally, several other
requirements must be met for this "exchange method"
to be tax-deferred or tax-free. In any event, the effect of
this step would be that the ownership of the SIFT Trust would
be transferred to a taxable Canadian corporation, which would
then be owned by the previous unitholders of the SIFT trust.
The Conversion Rules outline the mechanics for determining the
former unitholders' adjusted cost base and the paid up
capital in the newly issued shares. Furthermore, certain timing
requirements must be met, including that this conversion must
take place by 2013 and the unit-for-share exchange within a 60
day period, which period begins when the first unit is
exchanged for shares.
Another way in which unitholders will be able to convert
their units into shares is by a distribution of the shares of
the underlying corporation owned by the SIFT trust on the
redemption of all the units. As with the exchange method
outlined above, several requirements must be met for this
"redemption method" to be effective, but the results
should essentially be the same. The same timing requirements
apply to this manner of converting the unitholders'
units into shares.
Conversion: SIFT Trusts
Another aspect of the Conversion Rules is the elimination of
the SIFT trust and the transfer of the underlying business up
to the corporation. Where the property of the SIFT trust or
partnership is merely shares of a corporation, which are
transferred to the unitholders on the redemption of all of
their units, the SIFT trust or partnership is wound up on the
redemption of all of its units. This transfer and redemption
must be done properly, in the proper timeframe and in
compliance with all the technical requirements of the
Conversion Rules and the Tax Act.
Where the unitholders exchange their units for shares in a
taxable Canadian corporation, the SIFT trust or partnership
will then be wound up and all of its property will be
transferred to the corporation. This wind up will be similar to
the wind up of a wholly-owned subsidiary corporation into its
parent pursuant to subsection 88(1) of the Tax Act.
There are numerous consequential amendments to the Tax Act
as part of the Conversion Rules. For example, certain
amendments are proposed in respect of the debt forgiveness
rules designed to avoid immediate tax consequences on the
transfer of underwater debt as part of the conversion.
The foregoing is merely a brief summary of the Conversion
Rules and their potential tax consequences. As when conversions
into SIFT trusts (and SIFT partnerships) were originally
undertaken, experienced tax professionals should be consulted
to effect the de-conversion process and comply with the
Conversion Rules and the Tax Act. Finance has indicated that
they will consult with interested parties about the Conversion
Rules over the next 2 months. As such, it can be expected there
will be some revisions and changes, whether minor or major,
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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