Conversion of Trusts into Corporations
The BackgroundOn October 31st, 2006, the federal government announced plans to change the way most income trusts and limited partnerships were taxed. Under the government’s proposal (the SIFT Rules), certain publicly traded trusts were to be taxed on their non-portfolio income at rates of tax comparable to the combined federal and provincial corporate tax rate and to treat distributions of such income as dividends to unitholders. Previously, trusts and partnerships were permitted to avoid tax at the trust or partnership level by flowing their income through to unitholders.
SIFTs (Specified Investment Flow-through entities) that were in existence on October 31, 2006, under certain conditions, were permitted to continue to be entitled to flow-through tax treatment until 2011. As a result of the new tax rules, it was expected that SIFTs would convert into corporations prior to 2011. On July 14, 2008, the Department of Finance released draft amendments to the SIFT rules that allowed the conversion of certain income trusts into corporations on a tax-deferred basis. These conversion amendments apply to conversions after July 14, 2008 and before 2013 and are applicable to SIFTs that were in existence any time between October 31, 2006 and July 14, 2008.
Real Estate Investment Trusts (REITS), provided that they meet certain tests (most notably that of deriving 95% of their revenue from passive collection of rent on real property) will generally remain exempt. However, hotel and retirement/long term care REITS, as currently structured, would not qualify for this exemption since they derive significant income from operating activities.
How are Trust Conversions Taxed?The tax treatment of the conversion of a SIFT to a corporation can fall into one of three categories:
1. tax-deferred rolloverIn addition, certain SIFTs may decide not to convert or to choose to postpone conversion to a corporation at this time.
2. taxable event that generates a capital gain/loss
3. tax-deferred rollover if a joint tax election form is filed by a certain date
Finally, it is important to recognize that if an investor disposes of shares in a corporation that was originally purchased as an income trust or other type of SIFT, and during the holding period a portion of the distributions received was deemed to be return of capital (ROC), then a calculation of the adjusted cost base of the shares of the corporation factoring in the ROC must be made. In addition, if the trust made “phantom distributions” during the holding period, the investor would benefit from the resulting increase in the ACB.