The Government’s 2006 Tax Fairness Plan restored balance and fairness to the federal tax system by creating a level playing field between income trusts and corporations. The Plan’s detailed rules, which were enacted in 2007 and became fully effective this year, treat “specified investment flow-through” entities (SIFTs) in much the same manner as public corporations. At the time that the Tax Fairness Plan was announced, the Government indicated that, if there should emerge structures or transactions that are clearly devised to frustrate those policy objectives, any aspect of those measures may be changed accordingly and with immediate effect.
Today’s announcement reinforces the Government’s commitment to the policy objectives of the Tax Fairness Plan. Recent transactions involving publicly-traded stapled securities have raised concerns about the use of these types of structures in a manner that frustrates those policy objectives. The proposals announced today therefore include measures to limit the deductibility of certain amounts payable in respect of publicly-traded stapled securities.
The Government will continue to monitor Canadian tax planning for structures and transactions that might frustrate the policy objectives of the Tax Fairness Plan and will, as necessary, take appropriate corrective action.
Today’s announcement also adds a number of proposed amendments specific to the SIFT rules in response to issues that have been brought to the Government’s attention by taxpayers and their advisors.
References in this document to today should be read as today’s date.
Below are brief explanations of the proposed amendments announced today.
Some SIFTs, including real estate investment trusts (REITs), and corporations have introduced publicly-traded stapled securities into their capital structures. These securities have features that can provide tax advantages similar to those associated with earlier income trust structures.
What are stapled securities?
In general terms, a stapled security involves two separate securities that are “stapled” together such that the securities are not freely transferable independently of each other.1 The proposed amendments announced today 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:
What income tax amendments are proposed with respect to stapled securities?
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 income tax provisions are proposed to be 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.
What is the proposed effective date of the proposals for stapled securities?
The proposals announced today would apply to an entity in respect of an amount that is paid or becomes payable on or after today, 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 today. If those stapled securities include securities that were also issued and outstanding and stapled securities of the entity on October 31, 2006, the entity’s transition period would be the period that starts today and ends on January 1, 2016. Otherwise, the entity’s transition period would be the period that starts today and ends on the day that is one year after today. Notwithstanding these general rules, an entity’s transition period would end on the earliest day after today on which either a security of the entity becomes a stapled security of the entity3 or a stapled security of the entity is materially altered.
If the subsidiary of an entity does not itself otherwise have a transition period, the subsidiary’s transition period would be that of its parent entity, except that the subsidiary’s transition period would end on the earliest day after today on which either a security of the subsidiary becomes a stapled security of the subsidiary, or the subsidiary ceases to be a subsidiary of the parent entity.
The SIFT tax applies to publicly-traded trusts and partnerships. Special rules can apply in certain circumstances to treat an otherwise privately-held trust or partnership as a SIFT, unless the trust or partnership is an “excluded subsidiary entity”.
To qualify as an excluded subsidiary entity for a taxation year, an entity must meet two conditions at all times during the taxation year. The first is that the entity’s equity (including equity-like debt) not be listed or traded on a stock exchange or other public market at any time in the taxation year. The second is that its equity not be held at any time in the taxation year by any person or partnership other than certain qualifying interest holders. Currently, only REITs, taxable Canadian corporations, SIFTs and other excluded subsidiary entities are qualifying interest holders for this purpose.
The definition “excluded subsidiary entity” is proposed to be amended to expand the range of qualifying interest holders in such an entity. The expanded list would include a person or partnership that does not have any security or right, in the entity, that is, or includes a right to acquire, directly or indirectly either
This proposed amendment would be deemed to have come into force on October 31, 2006. However, an entity that would, only because of this proposed amendment, be an excluded subsidiary entity for a taxation year that begins on or before today, would be able to elect to have this change apply to it only for taxation years that begin after today.
A SIFT is a publicly-traded trust or partnership that holds “non-portfolio property”. Non-portfolio property includes a holding in another entity that exceeds certain concentration limits (for example, where the property held represents more than 10% of the equity value of the underlying entity). The concentration limit rule does not apply, however, where the underlying entity is a “portfolio investment entity”, being an entity that itself does not hold any non-portfolio property.
Today’s announcement also proposes a measure that would clarify – consistent with the Canada Revenue Agency’s current application of the SIFT regime – that non-portfolio property of a corporation has the same meaning as it does in respect of property of a trust or partnership. This change would also provide greater certainty as to which corporations qualify as portfolio investment entities. This proposed amendment would apply to taxation years that end after today.
The income tax rules contain an instalment system that imposes a requirement on affected taxpayers to pay a portion of their estimated tax liability for a taxation year in instalments over the course of the year.
SIFTs are currently subject to the instalment rules that apply to individuals. These rules require, when they apply, that instalment payments be made on a quarterly basis. Public corporations, on the other hand, are required to estimate tax instalments, and to pay the instalments on a monthly basis.
Today’s announcement proposes that the instalment regime be modified so that SIFTs are subject to the same monthly instalment rules that apply to public corporations. This proposed amendment would apply to taxation years that begin after today.
1 In some cases, the securities may be “unstapled” at the option of the investor or the issuer. Under these proposals, the unstapling of securities under such a feature would be ignored at a given time in determining whether a security is a stapled security at that time, unless the unstapling is permanent and irrevocable.
2 Under these proposals, a subsidiary of a particular entity would mean (a) an entity in which the particular entity holds equity that has a total fair market value that is greater than 10% of the equity value of the entity, and (b) an entity that is a subsidiary of an entity that is a subsidiary of the particular entity.
3 For this purpose, a security of an entity would not be considered to have become after today a stapled security of the entity if either (a) it was issued as part of a transaction the parties to which are obligated to complete under the terms of an agreement in writing between the parties entered into before today, and may not be excused from completing as a result of amendments to the Income Tax Act, or (b) the issuance of the security is in satisfaction of a right to enforce payment against the entity of an amount that became payable by the entity before today on a stapled security of the entity if that issuance was made under a term or condition, in effect today, of the stapled security.