All of our readers will be familiar with the regime, referred to as the "specified investment flow-through" or "SIFT" rules, first announced on Halloween of 2006 to impose an entity level tax on income funds. Among the many criticisms of the SIFT rules is their overly broad application. The new regime would have applied to many entities that clearly did not give rise to the policy concerns that motivated the Government to propose the new regime in the first place. Nevertheless, Department of Finance officials had not been warm to suggestions that the proposed regime be modified. However, late yesterday (December 20) the Department announced the intention to, in fact, address a number of concerns that had been raised in respect of the regime.

Key Points

Following is a brief description of some of the key proposed technical amendments.

1. The SIFT definition will be amended to exclude trusts and partnerships whose equity (and equity-like debt, if any) is not publicly-traded, and is wholly owned by a SIFT, a real estate investment trust ("REIT"), a taxable Canadian corporation, another entity meeting this test, or any combination of these types of entities.

Examples given in the announcement are the following:

  • Two publicly-traded corporations form a partnership to carry on a business venture. The public trading of the shares of the corporations will not cause the partnership to be considered a SIFT.
  • A SIFT trust creates a wholly-owned trust to hold certain of its properties. The subsidiary trust will not be considered a SIFT.

2. "Investments" in a trust or partnership, as defined in the rules, includes both equity and debt of the trust or partnership. Thus, a trust or partnership may be a SIFT if its debt is publicly-traded, even if it has no publicly-traded equity. The parameters of what constitutes "public trading" in the definition of a SIFT will be amended to exclude publicly-traded debt that meet the following requirements:

i. at least 90% of the fair market value of the debt is held by entities that are not affiliated with the trust or partnership; and

ii. none of the debt is "equity-like" debt.

The example given in the announcement is the following:

  • A Canadian corporation, a U.S. corporation and a pension fund form a partnership in Canada. The partnership issues "pure" debt on the public market. No more than 10% of the debt is held by entities affiliated with the partnership. The partnership will not meet the public trading test, and so will not be considered a SIFT, as long as it satisfies the above requirements.

3. The non-portfolio property ("NPP") test in the SIFT definition (which is relevant in determining if a trust or partnership will be subject to the SIFT rules) will be modified to exclude from the NPP definition securities of a "portfolio investment entity". A new definition of "portfolio investment entity" will be introduced. A "portfolio investment entity" will be any entity that holds no non-portfolio properties.

The example given in the announcement is the following:

  • A publicly-traded trust holds as its only property a significant (more than 10%) interest in another trust. The other trust holds no non-portfolio properties. Under the current rule, the publicly-traded trust's investment in the other trust is a non-portfolio property, and the publicly-traded trust would be a SIFT. Under the new version of the non-portfolio property test, the investment in the other trust would not be a non-portfolio property, and the publicly-traded trust would not be a SIFT.

This presumably will address the issue that the existing proposals created for "stacked" partnerships. For example, it hopefully will address the case of a partnership that is a "feeder fund" that holds interests in a private equity fund that is also a partnership.

4. Under the so-called "cumulative rule" in the definition of non-portfolio property, Canadian real, immovable or resource property is treated as non-portfolio property of an entity if the fair market value of all Canadian real, immovable or resource property held by the entity is greater than 50% of the entity's "equity value". "Canadian real, immovable or resource property" includes shares of a corporation, and interests in a trust or partnership, if more than 50% of their fair market value is derived directly or indirectly from any combination of real or immovable property situated in Canada, Canadian resource property or timber resource property, or other shares and interests that meet that test.

The definition "Canadian real, immovable or resource property" will be amended to exclude shares of taxable Canadian corporations and interests in SIFTs. As a result, those shares and interests will not be included in applying the "cumulative rule" to determine if an entity holds non-portfolio property. It is important to note, however, that the shares and interests may still be non-portfolio property under certain other rules.

The example given in the announcement is the following:

  • A publicly-traded trust invests exclusively in shares of resource companies, but it does not hold more than 10% of the fair market value of any of the resource companies, and none of the holdings represents more than 50% of the fair market value of the trust, nor does it use those holdings in carrying on a business in Canada. Under the new rule none of the trust's holdings will be considered to be non-portfolio property, and it will not be a SIFT. The announcement also included a number of further proposed changes applicable to REITs.

Timetable

The announcement indicated that the Department intends to release draft legislation to implement these proposals at the earliest opportunity in 2008, but that the amendments will apply, if enacted as proposed, on the same timetable as the existing SIFT taxation rules.