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Changes to REIT Rules

Issue

Established in 1993, Canadian REITs have proven to be profitable for investors nation-wide and the economy as a whole. Thanks to REITs, individuals can participate in the ownership of commercial properties and reap the benefits of stability, growth, and diversification that institutional and high net worth investors have enjoyed for decades. REITs are taking their place alongside real estate development companies globally as a desirable passive vehicle for holding stable income producing real estate and distributing those funds to income oriented investors.  Although REITs have been consistently growing, technical issues remain unresolved, and truly act as a hindrance to this emerging sector.

Position

REALpac believes that until these outstanding technical issues are resolved; Canadian REITs will be disadvantaged compared to their U.S., Australian and other global counterparts:

Outstanding Technical Issues:
Mortgages: It is not clear whether mortgages being held by a REIT (which risks the REIT being considered as carrying on a business, in which case the mortgages will constitute non-portfolio property) is permitted. It needs to be allowed at least on a limited basis, as many REITs need the flexibility of granting vendor take back mortgages on a sale, or granting mezzanine loans to a developer to obtain an option on future developed income producing properties.
Income Account Properties: Properties held as inventory, where a REIT develops and has to sell off in the process a parcel or parcels of property upon the completion of a retail development, may dis-entitle the entity to REIT status even if the initial intention was to develop the property as capital properties of the trust. Incidental de minimus sales should be permitted.
Parking Areas: It is not clear when parking areas will be considered ancillary to an income producing property and therefore "good” assets. There are so many possible combination's of underground vs adjacent parking lots, owner operated vs third party managed, and tenant use vs. mixed use. REIT managements need more guidance and clarity in the legislation.
Trust on Trust Structure: We appreciate that the legislation has proposed to fix the trust on trust structuring issue for "rent from real or immovable properties”. However, the legislative fix is incomplete. The legislation clarifies that "rent” paid to a trust and distributed as income is derived from real property. However, interest and capital gains from the disposition of real property – "good” income under the REIT revenue tests – do not retain their source when earned by a subsidiary trust and distributed to the beneficiary. This may be a problem for a subsidiary entity which holds substantial mortgages receivable or has realized a substantial gain on the disposition of real property. A "consolidated” test may solve this problem, or a specific legislative fix.
SIFT Limited Partnership Issue: A partnership contained in a REIT could be subject to specified investment flow-through (SIFT) tax. It further appears that SIFT tax could be applied at the trust level and the partnership level. A SIFT partnership is also unable to qualify for the REIT exemption. There appears to be no exclusion where one of the other partners in a limited partnership is an individual, a tax exempt entity, a non-resident trust or a trust that is not a SIFT or a REIT.
No Curative Provisions: Unlike U.S. REIT legislation, there are no curative provisions apparent in the legislation to a REIT that has accidentally breached the SIFT rules. A softer regime for temporary and unintended breaches needs to be available.
No De Minimus NPP: There are no apparent provisions to allow ownership of de minimus (e.g., less than 5%) non-portfolio property. This should be enacted to avoid a minor acquisition mistake from tainting the entire REIT.

Previous Government Submissions

2011
Proposed Amendments to the Real Estate Investment Trust Rules: Minister of Finance Jim Flaherty

2010
Canada's Economic Action Plan: Pre-Budget 2011 Consultation

Letter to the Ministry of Finance re: European Parliament and Council Directive on Alternative Investment Fund Managers (AIFMs) and the amendment of Directives 2004/39/EC and 2009/…/EC

"Consultation Submission on Canada's Retirement Income System: Recognizing Real Estate Investment Trusts (REITs) as a Valuable Part of Senior's Retirement Income", Department of Finance

REIT Submission to Ministry of Finance

2009
"REIT Ancillary Issues" document submitted to the Minister of Canada Revenue Agency's office

2008

"REIT Rules: Letter to the Minister of Finance"Sent to Federal Finance Minster

Contact

For more information on this issue, or any of REALpac's government relations initiatives, please contact Ryan J. Eickmeier, Manager, Government Relations & Policy at (416) 642-2700 x.224.

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Real Property Association of Canada
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