Explanatory Notes to Legislative Proposals Relating to Income Tax Clause 1 SIFT trusts and SIFT partnerships ITA 122.1 Section 122.1 of the Income Tax Act (the “Act”) sets out rules that apply in respect of the taxation of specified investment flow-through (SIFT) trusts and, in some cases, SIFT partnerships. “SIFT trust” is defined in subsection 122.1(1), and “SIFT partnership” is defined in section 197 of the Act; both definitions are made by subsection 248(1) of the Act to apply for all purposes of the Act. Definitions ITA 122.1(1) Subsection 122.1(1) of the Act sets out a number of definitions that apply for the purposes of the rules for SIFT trusts and, in some cases, SIFT partnerships. The definitions in subsection 122.1(1) apply for the purposes of sections 104 and 122, as well as for the purposes of section 122.1. Subsection 122.1(1) is amended by adding several definitions and modifying a number of others. These amendments apply to the 2011 and later taxation years, and also, on an elective basis, for earlier taxation years (i.e., the 2007, 2008, 2009 and 2010 taxation years). The following notes describe the new and amended definitions in alphabetical order. “eligible resale property” The new definition “eligible resale property” is added as part of a series of amendments intended to allow REITs to hold certain kinds of non-capital property in limited circumstances. “Eligible resale property” of an entity is defined as real or immovable property held by the entity if • •

the entity itself is one in which a publicly-traded trust (i.e., the trust seeking to qualify as a REIT) holds a security, the property is contiguous to a particular real or immovable property that is capital property of the entity or of an entity in which the trust holds an interest, and

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the holding of the property is necessary and incidental to the holding of the particular real or immovable property.

This amendment is intended to allow for the temporary holding by a REIT’s subsidiary of non-capital property which is contiguous to the capital property described above, as well as necessary and incidental to the holding of that capital property. Such property may include a portion of a commercial development of a REIT that is to be severed for the ownership and use of an anchor tenant, where the holding of such property is necessary and incidental to the holding of the commercial development. “gross REIT revenue” The new definition “gross REIT revenue” applies for purposes of the definition “real estate investment trust”. The new definition clarifies that the concept of revenue in the context of REITs is comprised of gross receipts and receivables as well as capital gains. Accordingly, proceeds of disposition that are not included in capital gains, such as recapture, are not intended to be included in gross REIT revenue. “qualified REIT property” The definition “qualified REIT property” applies in determining whether a trust is a REIT for purposes of the SIFT rules. In order to qualify as a REIT, a trust cannot hold any non-portfolio property other than qualified REIT property. The existing definition “qualified REIT property” describes four types of property. The second type of qualified REIT property, described in paragraph (b) of the definition “qualified REIT property”, consists of securities of a subject entity that derives all or substantially all of its revenues from maintaining, improving, leasing or managing real or immovable properties that are capital properties of the trust or of an entity of which the trust holds a share or an interest. The description of this type of qualified REIT property is amended to extend qualified REIT property status to shares of a subject entity that derives all or substantially all of its revenues from maintaining, improving, leasing or managing real or immovable property that is either capital property, or eligible resale property, of the trust or of an entity of which the trust holds a share or an interest. Paragraph (a) of “qualified REIT property” is consequently amended to apply only in respect of real or immovable property that is capital property of the trust. These amendments are intended to allow for the occasional holding by a REIT or its subsidiary of non-capital property which is contiguous to the capital property described above, as well as necessary and incidental to the holding of that

capital property. For more detail, see the commentary on the new definition “eligible resale property”. The fourth type of qualified REIT property is property that is ancillary to the earning by the trust of rent from real or immovable properties and capital gains from dispositions of real or immovable properties. For example, a REIT can hold office furniture and computers that are ancillary to its operations. The description of this type of qualified REIT property is amended to clarify that only tangible personal property can qualify as ancillary in this regard. Further to the above amendment, as part of the harmonization of federal legislation, the Government has undertaken to review all its legislation where provincial law concepts are found in order to reflect appropriately the common law and the civil law, in both official languages. As a result, the French version of the legislation is amended to add the term “bien personnel tangible” in order to reflect the common law, and the English version of the legislation is amended to add the term “corporeal moveable property” in order to reflect the civil law. “real estate investment trust” A trust is a “real estate investment trust” (REIT) for a taxation year if it is resident in Canada throughout the year and meets a number of other conditions, including under paragraph (a) of that definition, the requirement that the trust at no time in the taxation year holds any non-portfolio property other than qualified REIT properties. This condition is amended so that only 90% of the REIT’s nonportfolio properties must be, at all times in a taxation year, qualified REIT properties. Paragraphs (b) and (c) of this definition are also amended to clarify the nature of the trust’s revenue that is intended to be measured. For more detail, see the commentary on the new definition “gross REIT revenue”. Paragraph (b) is also amended to only require that 90% of a REIT’s revenues be from certain passive sources and to include gains from the disposition of eligible resale properties as a qualifying source of REIT revenue under that paragraph. For more detail, see the commentary on the definition “qualified REIT property” and on the new definition “eligible resale property”. Paragraph (e) is added to the definition to clarify that a condition for a trust of being a REIT is that its investments are listed or traded on a stock exchange or other public market. This change is consequential to the amendment, described elsewhere in this commentary, to the definition “Canadian real, immovable or resource property” in subsection 248(1).

“rent from real or immovable properties” “Rent from real or immovable properties” is currently defined to include a payment out of the current income of a trust, but only to the extent that the payment is included in the recipient trust’s income and is paid from the part of the payer trust’s income that was derived from rent from real or immovable properties. The subparagraph that includes the above payments in “rent from real or immovable properties” is repealed as part of a set of clarifying amendments to provide for what sources of revenues maintain their characterization when flowed through certain subsidiary trusts. For more detail, see the commentary on new subsections 122.1(1.1) and (1.2) and the definition “gross REIT revenue” in subsection 122.1(1). Revenue Characterization flow-through ITA 122.1(1.1), (1.2) New subsections 122.1(1.1) and (1.2) of the Act set out a rule clarifying the application of paragraphs (b) and (c) of the definition REIT in subsection 122.1(1) of the Act. These two new subsections provide that where a trust has an interest in another trust, and that interest is non-portfolio property of the first trust, then the revenues flowed through the subsidiary trust maintain their source characterization in determining the source of revenues of the second trust. This rule is intended to clarify the application of the portions of the above definition that concern the trust’s revenues. These amendments apply to the 2011 and later taxation years, and also, on an elective basis, for earlier taxation years (i.e., the 2007, 2008, 2009 and 2010 taxation years). Currency fluctuations and foreign real or immovable property ITA 122.1(1.3) New subsection 122.1(1.3) of the Act applies for purposes of the definitions “real estate investment trust” and “qualified REIT property”. This subsection is intended to allow a REIT to treat, as qualifying REIT revenue, foreign currency gains included in the REIT’s gross revenue and realized in respect of •

qualifying sources of REIT revenue (such as rental revenue from real or immovable property situated in the United States); and

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debt incurred for the purpose of earning revenue from a qualifying source of REIT revenue (such as Euro-denominated debt incurred by the REIT to acquire real or immovable property in Germany from which the REIT earns rental revenue).

This subsection is also intended to allow a REIT to treat, as qualifying REIT revenue, amounts included in the REIT’s gross revenue and received under, or as a result of, an arrangement that hedges risk stemming from fluctuations in foreign currency of a country in which the REIT holds real or immovable property. This amendment applies to the 2011 and later taxation years, and also, on an elective basis, for earlier taxation years (i.e., the 2007, 2008, 2009 and 2010 taxation years). Clause 2 Interpretation ITA 248(1) Subsection 248(1) sets out a number of definitions for the purposes of the Act. The subsection is amended by modifying the definition “Canadian real, immovable, or resource property”. “Canadian real, immovable or resource property” The definition “Canadian real, immovable or resource property” applies in the context of the taxation of “SIFT trusts” and “SIFT partnerships”. It is defined to mean four types of properties and any right to or interest in them. The fourth type of property specified as being “Canadian real, immovable or resource property” is a share of the capital stock of a corporation, an income or capital interest in a trust or an interest in a partnership, excluding certain taxable entities, if more than 50% of the fair market value of the share or interest is derived directly or indirectly from one or any combination of properties that are real or immovable property situated in Canada. The description of this type of property is amended to further exclude interests in REITs, and interests in SIFT trusts and partnerships without reference to subsections 197(8) and 122.1(2) respectively (i.e., trusts and partnerships that would be SIFTs except for the transitional relief provided by those subsection for taxation years that end before 2011). This amendment applies to the 2011 and later taxation years, and also, on an elective basis, for earlier taxation years (i.e., the 2007, 2008, 2009 and 2010 taxation years).