February 20, 2013
New REIT Rules — Welcome Improvements
Certain trusts may benefit from recent legislative changes to ease the requirements to qualify as a real estate investment trust (REIT) for income tax purposes. The proposed changes will not only ease the property and revenue restrictions of trusts that already qualify as REITs, but may also provide REIT status to trusts that did not qualify under the old rules (and were potentially subject to the tax applicable to specified investment flow-through (SIFT) entities). Some of these trusts may find that they are now able to qualify for the exemption from SIFT tax available to a properly organized REIT.
The new tax rules are generally relieving in nature and have been well received by the Canadian REIT community. It is encouraging that the government has listened to the industry’s concerns and acted on them.
The new rules apply to 2011 and later taxation years but under a special elective provision, they may also apply retroactively to a post-2006 taxation year of a REIT if certain conditions are met. Although the bill that includes these new rules has received first reading and is considered substantively enacted for IFRS and ASPE, it is unclear how quickly the bill will make its way through Parliament and when it will be formally passed into law.
This TaxNewsFlash-Canada summarizes the new (and improved) rules as they are meant to apply when finally enacted into law.
What is a REIT?
For Canadian income tax purposes, a trust is a REIT for a particular taxation year and therefore not subject to the SIFT tax if, throughout the year, it is resident in Canada and passes each of the following tests:
· Property test
· 90% passive revenue test
· 75% real property revenue test
· Qualifying property value test
· Publicly traded test.
The publicly traded test, which requires that investments in the REIT be publicly listed or traded, was added under the new rules.
What is the property
Previously, a REIT was not permitted to hold any non-portfolio property at any time during the year, other than qualified REIT property. The new rules amend the property test so that a REIT is now allowed to hold up to 10% of its non-portfolio property in assets that are not qualified REIT property.
· Securities of an entity that represent more than 10% of the equity value of the entity or more than 50% of the equity value of the security holder
· Canadian real, immovable or resource property, if it, along with all of the entity’s Canadian real, immovable or resource property, represents more than 50% of the entity’s equity value
· Property used in carrying on a business in Canada.
This definition has not changed in the new rules.
What is qualified REIT
· Real or immovable property that is capital property, an “eligible resale property”, bankers’ acceptance of a Canadian corporation, money, or certain government debt or deposits with a credit union
· Property ancillary to earning by the trust of rents and dispositions of real or immovable properties that are capital properties, other than an equity of an entity or a mortgage, hypothecary claim, mezzanine loan or similar obligation
· Certain types of qualifying subsidiaries (generally, “property management subsidiaries” or “title nominees”).
In determining whether property is ancillary to the earning of rent and realized gains from the dispositions of real or immovable properties, the new rules provide only for the specific exclusion of all equity and certain debt interests.
The definition of qualified REIT property has also been expanded under the new rules such that it includes the assets described in the qualifying property value test.
What is eligible
Eligible resale property is real or immovable property of an entity that is:
· Not capital property
· Contiguous to a particular real or immovable property that is either capital property or eligible resale property of the entity or of an affiliated entity, and
· Is ancillary to the holding of that particular real or immovable property or eligible resale property.
90% passive revenue test
The passive revenue test requires the REIT to derive not less than 90% (down from 95% under the old rules) of the trust’s “gross REIT revenue” for the taxation year from:
· Rent from real or immovable properties
· Dispositions of real or immovable properties that are capital properties
· Dispositions of “eligible resale properties” (see definition above).
The inclusion of revenue from the disposition of eligible resale properties was originally introduced under the 2010 proposals.
Rent from real or immovable properties includes rent or similar payments for the use of, or right to use, real or immovable properties, and payments for services ancillary to the rental of real or immovable properties and customarily supplied by a landlord to its tenant.
75% real property revenue test
The real property revenue test requires that not less than 75% of the trust’s gross REIT revenue for the taxation year be derived from:
· Rent from real or immovable properties
· Interest from mortgages, or hypothecs, on real or immovable properties
· Dispositions of real or immovable properties that are capital properties.
Although dispositions of eligible resale properties are now qualifying revenue under the passive revenue test, such amounts are not qualifying revenue under the real property revenue test.
The new rules do not make any significant changes to the real property revenue test.
What is gross REIT revenue?
The new rules clarify that both the passive revenue test and the real property revenue test are based on “gross REIT revenue”, which is defined as the amount by which the total of all amounts received or receivable in the year by the trust exceed the cost to the entity of properties disposed of in the year.
· Is affiliated with that entity, or
· Holds securities of the source entity (namely, shares if the entity is a corporation, an income or capital interest if that entity is a trust, or a partnership interest if the entity is a partnership) that have a total fair market value that is greater than 10% of the source entity.
These character preservation rules apply to the revenue received or receivable by a REIT from qualifying subsidiaries unless that revenue can reasonably be considered to be derived from certain property management revenue (i.e., revenue from maintaining, improving, leasing or managing real or immovable properties that are capital properties of the REIT, or an entity in which the trust holds a share or interest).
The explanatory notes accompanying the new rules state that these character preservation rules are intended to work iteratively through a chain of ownership of several levels of subject entities.
The new rules deem certain amounts included in gross REIT revenue to have the same character as gross REIT revenue in respect of the underlying real or immovable property that result from:
· Interest-rate hedges entered into by the REIT in respect of debt incurred by the REIT to acquire or re-finance real or immovable property, and
· Foreign currency gains in respect of real or immovable property situated in a country other than Canada recognized on:
(i) revenue of such non-Canadian real or immovable property
(ii) debt incurred by the trust for the purpose of earning such non-Canadian revenue, or
(iii) foreign currency hedges.
Qualifying property value test
Under the qualifying property value test, at least 75% of the trust’s “equity value” throughout the taxation year must be comprised of the total fair market value of a trust’s real or immovable property, bankers’ acceptance of a Canadian corporation, money, or certain government debt or deposits with a credit union.
For taxation years ending after 2012, the new rules require that the real or immovable property for purposes of this test must be either capital property or eligible resale property.
New rules’ retroactive application
The new rules apply to the 2011 and subsequent taxation years. The new rules may also apply to a taxation year of a REIT ending after 2006 if the investments in the REIT are listed or traded in that earlier year and the REIT elects in writing on or before its filing due-date for its taxation year that includes the day on which the new rules receive Royal Assent.
The ability to elect to have these rules apply retroactively may benefit a REIT that was not eligible for the grandfathered exemption from the SIFT tax (for example, a REIT that became publicly traded after October 31, 2006 or a REIT that exceeded its normal growth guideline).
A REIT is not always a REIT
A properly structured trust that holds only non-Canadian real or immovable properties is not a SIFT trust and does not have to meet the REIT conditions.
KPMG observations — Structural and activity issues
Although the new rules address most of the concerns raised by members of the real estate industry, the following technical issues and tax policy restrictions should be considered:
Proposed legislation expands the list of qualifying interest holders to include persons (including individuals, trusts, tax-exempt entities, or non-residents) that do not have a right, in connection with the holding of such interest, to property the value of which is determined by reference to a publicly traded security.
Therefore, a REIT’s subsidiary partnership may still be a SIFT partnership and subject to SIFT tax if an individual holds an interest in the partnership that is exchangeable into the REIT’s publicly traded units.
Hotels and seniors’
We can help
KPMG's Building, Construction & Real Estate Practice has more than 300 professionals dedicated to serving the real estate needs of our clients. We operate nationally as a fully integrated business unit so that all of our multi-functional skill sets and experience is available to our clients.
We provide a wide range of independent reporting, tax, valuation and corporate finance advisory services to participants in the Canadian real estate industry, including REITs, pension funds, investment funds, private investors, banks and life insurance companies, private developers and corporate landlords and tenants of real estate.
Our multi-disciplinary team with the combined skills of chartered accountants, valuators, MBAs and bankers is dedicated to serving our clients' real estate needs. We work closely with our real estate colleagues worldwide to apply specific accounting, tax, advisory and consulting expertise to assist our clients in today's challenging real estate market.
For details, please contact your KPMG adviser or one of the following:
Information is current to February 19, 2013. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
KPMG LLP, an Audit, Tax and Advisory firm (kpmg.ca) and a Canadian limited liability partnership established under the laws of Ontario, is the Canadian member firm of KPMG International Cooperative (“KPMG International”). KPMG member firms around the world have 145,000 professionals, in 152 countries.
The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss entity. Each KPMG firm is a legally distinct and separate entity, and describes itself as such.
KPMG's Canadian Web site is located at http://www.kpmg.ca/
© 2013 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.