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Canada Amends 'Tax Fairness' Law

Friday, July 22, 2011

The Canadian government is to amend its income tax legislation to bring in changes to the tax treatment of specified investment flow-through entities (SIFTs), real estate investment trusts (REITs) and publicly-traded corporations. The changes were announced on July 20.

According to the government, its SIFT rules, in effect since 2007, have restored balance and fairness to the income tax system by leveling the playing field between publicly-traded trusts and partnerships and public corporations, by treating SIFTs in much the same manner as public corporations. When the government first introduced the proposals in 2006, as part of the Tax Fairness Plan, it indicated that, were there to emerge any structures or transactions clearly devised to frustrate the plan's objectives, the rules could be changed accordingly, and with immediate effect. An SIFT is a publicly-traded trust or partnership that holds “non-portfolio property”.

The rules are to be amended because recent transactions involving publicly-traded stapled securities have raised concerns about the use of these types of structures in a manner that frustrates the policy. Some SIFTs, including REITs and corporations, have introduced these securities into their capital structures. The securities have features that can provide tax advantages similar to those associated with earlier income trust structures. The new proposals include measures to limit the deductibility of certain amounts payable in respect of these securities.

The new rules would apply to the stapled securities of an entity that is a trust, corporation or partnership, if one or more of the stapled securities is listed or traded on a stock exchange or other public market and 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 the subsidiary of a REIT.

In some structures involving stapled securities, a corporation or SIFT (alone or together with a subsidiary) might issue equity and debt instruments – at least one of which is publicly-traded – that are stapled together. The proposals would see income tax provisions amended to provide that, notwithstanding the general rules applicable to the deductibility of interest, interest that is paid or payable on the debt portion of such a stapled security will not be deductible in computing the income of the payer for income tax purposes. Accordingly, stapling arrangements that involve only shares issued by publicly-traded corporations, the distributions on which are treated as dividends for tax purposes, are not intended to be affected by the amendment.

In other structures, a REIT (or a subsidiary of a REIT) might issue a security to its investors in circumstances in which the security similarly can be transferred only together with an interest in another entity, such as a trust or a corporation. Typically, the other entity, directly or through its subsidiaries, carries on a business or holds property that the REIT could not carry on or hold directly without losing its status as a REIT. The income tax provisions are proposed to be amended to provide that, notwithstanding the general rules applicable to the deductibility of amounts, any amount (including, but not limited to rent) that is paid or payable by the other entity (or its subsidiaries) to the REIT (or its subsidiaries, and including “back-to-back” intermediary arrangements) will not be deductible in computing the income of the payer for income tax purposes.

In addition, the government will continue to monitor Canadian tax planning for structures and transactions that might cause problems for the policy and will, as necessary, take appropriate corrective action.

The proposals would apply to an entity in respect of an amount that is paid or becomes payable on or after July 20, unless the amount is paid or becomes payable during, and is in respect of, the entity’s transition period. An entity would have a transition period only if stapled securities of the entity were issued and outstanding on the day immediately before July 20.

Commenting on the plans, Finance Minister Jim Flaherty said: “These proposed measures will ensure that the policy objectives of the Tax Fairness Plan continue to be met. They also reflect our government’s ongoing commitment to address structures that frustrate those policy objectives.”