Real estate investment trusts (“REITs”) are publicly-traded trusts holding non-portfolio property that are exempt from the tax on distributions from a specified investment flow-through (“SIFT”). The proposals announced today contemplate amendments to the rules for qualification as a REIT. The proposals will be effective for the 2011 and subsequent taxation years and also on an elective basis for earlier taxation years. Below are brief explanations of several key elements of the proposed amendments.
Use of Property Held for Resale in Incidental Business Activities
A REIT that acquires property and arranges for its development to hold as a commercial rental property may often resell a portion of that property to another party, such as a desired anchor tenant. A REIT may also acquire property for resale in the condominium and foreclosure contexts.
Today’s proposals would allow REIT subsidiaries to hold, and generate the revenues associated with, certain real estate held for resale that is necessary and incidental to the REIT holding capital property that is qualified REIT property.
Qualified REIT Property
The proposals will permit REITs to hold up to 10% of their property in the form of non-portfolio property that is not qualified REIT property. Consequential to this relieving change, the existing provision for ancillary qualified REIT property is clarified to better describe the type of properties that can be considered ancillary. In particular, only tangible personal property, or for civil law purposes corporeal moveable property, (and, therefore, excluding securities such as equity and debt) can qualify as ancillary for this purpose.
Gross REIT Revenue
In order to qualify as a REIT, a trust must meet two tests designed to determine the nature of its revenue. The REIT rules provide that at least 95% of a REIT’s revenues must be derived from passive sources generally, and that, in particular, at least 75% of a REIT’s revenues must be sourced from certain passive real estate sources.
The rule providing that at least 95% of a REIT’s revenues be derived from certain passive sources is proposed to be modified to require that only 90% of the REIT’s revenues be derived from qualifying sources.
Today’s proposals will also clarify that, for both revenue tests, revenue is to be defined as gross revenue, and will include capital gains.
Foreign Currency Gains
When REITs hold foreign real or immovable property, they may finance the acquisition of such property using debt denominated in a foreign currency. Also, given the potential foreign currency risk in holding foreign assets, REITs may choose to enter arrangements that hedge that risk.
Today’s proposals will permit REITs to earn, as qualifying revenue, gains realized by virtue of foreign currency fluctuations in respect of revenues derived from such foreign real or immovable property including certain financing and hedging arrangements in respect of such property.
Source Character of Revenue from a Subsidiary Trust
The proposals will ensure that, for purposes of the two revenue tests referred to above (the 95% and the 75% test), amounts paid by certain subsidiaries of a REIT to the REIT will have the same character as that revenue had when it was received or earned by those subsidiaries.
Canadian Real, Immovable or Resource Property
The proposals will ensure that an entity may hold investments in a REIT or transitional SIFT without those investments being treated as Canadian real, immovable or resource property in determining whether the entity itself is a SIFT. For this purpose, a transitional SIFT means a trust or partnership that would, but for the deferred application of the rules for entities that existed on October 31, 2006, be a SIFT trust or SIFT partnership.
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