As promised the Department of Finance (Canada) ("Finance"), on July 14, 2008, released its draft technical amendments (the "Conversion Rules") to the Income Tax Act (Canada) (the "Tax Act") which are designed to allow, where certain requirements are met, publicly traded income trusts, known as SIFT trusts (as well as publicly traded limited partnerships, known as SIFT partnerships) to convert to taxable Canadian corporations on a tax-deferred basis.
Taxation of Publicly Traded Income Trusts
On October 31, 2006, the Department of Finance (Canada) announced its plan to tax SIFT trusts (and SIFT partnerships) as corporations. While this announcement effectively put an end to the creation of new SIFT trusts as well as the conversion of publicly traded corporations into SIFT trusts, it also raised the question of how existing SIFT trusts would be permitted to be converted back into corporate form without drastic negative tax consequences. Many of these SIFT trusts had incurred substantial tax costs on their initial conversions from corporations and to be taxed again on their conversion back into corporations was seen as unnecessarily punitive. In response to this concern, Finance agreed to devise a scheme whereby these SIFT trusts could convert to corporations in a tax-free or tax-deferred manner. The draft technical amendments from July 14, 2008, or the Conversion Rules, are designed to do just that.
Under the Conversion Rules, unitholders (both in SIFT trusts and SIFT partnerships) will be entitled to transfer their units to a taxable Canadian corporation on a tax-deferred basis in exchange for shares of a that corporation. All of the shares of the corporation issued as a part of this exchange must be of the same class of shares. Additionally, several other requirements must be met for this "exchange method" to be tax-deferred or tax-free. In any event, the effect of this step would be that the ownership of the SIFT Trust would be transferred to a taxable Canadian corporation, which would then be owned by the previous unitholders of the SIFT trust. The Conversion Rules outline the mechanics for determining the former unitholders' adjusted cost base and the paid up capital in the newly issued shares. Furthermore, certain timing requirements must be met, including that this conversion must take place by 2013 and the unit-for-share exchange within a 60 day period, which period begins when the first unit is exchanged for shares.
Another way in which unitholders will be able to convert their units into shares is by a distribution of the shares of the underlying corporation owned by the SIFT trust on the redemption of all the units. As with the exchange method outlined above, several requirements must be met for this "redemption method" to be effective, but the results should essentially be the same. The same timing requirements apply to this manner of converting the unitholders' units into shares.
Conversion: SIFT Trusts
Another aspect of the Conversion Rules is the elimination of the SIFT trust and the transfer of the underlying business up to the corporation. Where the property of the SIFT trust or partnership is merely shares of a corporation, which are transferred to the unitholders on the redemption of all of their units, the SIFT trust or partnership is wound up on the redemption of all of its units. This transfer and redemption must be done properly, in the proper timeframe and in compliance with all the technical requirements of the Conversion Rules and the Tax Act.
Where the unitholders exchange their units for shares in a taxable Canadian corporation, the SIFT trust or partnership will then be wound up and all of its property will be transferred to the corporation. This wind up will be similar to the wind up of a wholly-owned subsidiary corporation into its parent pursuant to subsection 88(1) of the Tax Act.
There are numerous consequential amendments to the Tax Act as part of the Conversion Rules. For example, certain amendments are proposed in respect of the debt forgiveness rules designed to avoid immediate tax consequences on the transfer of underwater debt as part of the conversion.
The foregoing is merely a brief summary of the Conversion Rules and their potential tax consequences. As when conversions into SIFT trusts (and SIFT partnerships) were originally undertaken, experienced tax professionals should be consulted to effect the de-conversion process and comply with the Conversion Rules and the Tax Act. Finance has indicated that they will consult with interested parties about the Conversion Rules over the next 2 months. As such, it can be expected there will be some revisions and changes, whether minor or major, forthcoming.