Following the federal Government's announcement on October 31, 2006 that the tax-favoured status of income funds would be eliminated by 2011, income funds have been anxiously awaiting the enactment of tax measures to facilitate conversion to a corporation. Those conversion rules came into force on March 12, 2009, enabling income funds to now chart their course of action.

What follows is a summary description of considerations relevant to when and how to convert. Of course, an income fund should review its particular circumstances with its accounting and legal advisors before a decision is made as to the best way to proceed.

When to Convert

Tax-Favoured Status Ends January 1, 2011

  • Conversions must be effected before January 1, 2013
  • Does income fund have other sources of tax shelter to justify converting either before or after January 1, 2011?

Economic and Market Factors

  • Declining income fund market, analysts' coverage and investor following
  • Distributions reduced, suspended or at risk
  • Difficulty renewing credit and raising capital
  • Should conversion be combined with a sale, purchase or go-private transaction?
  • What do the unitholders want?

Advantages of Corporate Structure

  • Better access to capital
  • Share structure more commonly understood by all stakeholders
  • Expected retention of cash for acquisitions and reinvestment in the business
  • No foreign ownership limitations
  • Well established framework for governance, directors' liability and corporate reorganizations
  • Simplified structure brings reduced costs

Duties of Trustees

  • Must act in the best interests of unitholders
    • Consider how and when to best provide a tax-efficient maximum return for unitholders
    • Be impartial as between unitholders
  • Similar standard of care, skill and diligence to that of directors of corporations
  • Trustees' decisions generally not challenged, if
    • sought all necessary legal and financial advice
    • actions are honestly believed to be in the best interest of unitholders
    • self interest avoided
  • Record of proper process is important to minimize potential for claims against trustees

How to Convert

Two Methods of Conversion

  • Unit exchange
    • Unitholders exchange their units for shares of a new corporation (Newco) on an automatic tax deferred basis
      • Investor(s) can elect out of automatic rollover in order to realize a full or partial gain
    • Newco's shares are publicly listed
    • Entity below income fund (e.g. commercial trust) is wound up and its assets (e.g. units of the limited partnership, shares of the general partner, and promissory notes, as applicable) are distributed to the income fund
    • Income fund is wound up and the property it received is distributed to Newco

Results  

  • Former unitholders hold shares of Newco, a publicly traded corporation.
  • In the example given above, Newco is a limited partner of the limited partnership and it also owns all of the shares of the general partner and the promissory notes
  • The tax attributes of the income fund (and commercial trust, if applicable), such as losses etc., are transferred to Newcowhereas they are not transferred under the "redemption" method, below
  • If FMV of Newco shares and units are not equal, a taxable shareholder benefit may be triggered  
  • Redemption
    • Newco is incorporated
    • Entity below income fund (e.g. commercial trust) transfers its assets (e.g. units of the limited partnership, its shares of the general partner and promissory notes) to Newco on a tax deferred basis in exchange for common shares of Newco
    • In the example given above, commercial trust distributes its shares of Newco to the income fund on a tax deferred basis
    • Income fund redeems units held by the public in exchange for shares of Newco
    • Newco's shares are publicly listed

Results

  • Former unitholders hold shares of Newco, a publicly traded corporation
  • In the example given above, Newco is a limited partner of the limited partnership and it also owns all of the shares of the general partner and the promissory notes
  • The tax attributes of the income fund (and the commercial trust, if applicable) are NOT transferred to Newco
  • Holders of exchangeable units of limited partnership, if applicable, can also transfer those units to Newco in exchange for shares of Newco on a tax deferred basis
  • Options and DSUs granted under income fund structure may be exchanged for options and DSUs of Newco on a tax deferred basis
  • Housekeeping rules allow income fund (and commercial trust, if applicable) to be wound up without negative tax consequences

Conversion Transactions Effected by Plan of Arrangement

  • Provides flexibility to accomplish a number of steps contemporaneously under one instrument
  • Provides a prospectus and registration exemption in Canada (and a registration exemption in the US)
  • Timeline is approximately 3-4 months
  • Special meeting of unitholders to be called
  • Information circular in prescribed form to be provided to unitholders in advance of meeting
  • Fairness opinion from a financial adviser generally required
  • Amendments typically need to be made to the income fund's declaration of trust

Approvals Required

  • 66-?% unitholder approval
    • Holders of income fund units and exchangeable limited partnership units (if applicable) vote as one class, unless limited partnership unitholders treated differently
    • If any trustee, director, officer or other related party of the income fund pre-conversion is entitled to any "collateral benefit" under the plan of arrangement, it would constitute a "business combination" for Ontario securities law purposes requiring majority of minority approval
    • Unitholders have dissent rights (i.e. to be paid fair value in cash instead of participating)
  • Interim and final court approval (typically granted as a matter of course provided the plan of arrangement procedures have been followed and it is "fair and reasonable")
  • TSX approval (typically granted as a matter of course)
  • Listing of shares post-conversion treated as a "substitute listing" by TSX
  • Third parties, as applicable
    • Lenders and other debt holders under credit facility, loan and security documents
    • Customers and suppliers under material contracts
    • Employee considerations