Simplified Creations of Canadian REITs

For tax purposes, the Canadian real estate investment trust (“REIT”)¹ is firstly a “mutual fund trust” (“MFT”)² that serves as a conduit if it is also an REIT under the Income Tax Act³ and makes appropriate distributions and elections. Under those conditions, only its unitholders are subject to income tax. The tax rules applicable to an MFT are intended to place its unitholders in a situation similar to that in which they would be if they held real estate directly. In other words, it is an inter vivos trust within the meaning of our civil Laws (the Civil Code of Québec or Common Law) to which the ITA anti-conduit rule does not apply, since it is an REIT.⁴

We will discuss certain listing rules in Canada, primarily regarding a listing on the TSXV of an MFT that will also be an REIT. Specifically, an inter vivos trust residing in Canada listed on a Canadian designated stock exchange that almost exclusively holds real estate located in Canada as an investment and whose unit holders are residents of Canada. It should be noted that listing is one of the conditions that must be met according to the ITA’s definitions of an MFT and of a REIT.⁵

Initial public offering

In general, the initial public offering of a trust that will be an REIT may be made as described below. Consolidation with an REIT that is already publicly traded is another possibility, but that is not the subject of this article.

A new REIT may be listed on a stock exchange, either as part of:

1. An IPO: An initial public offering by a trust, where after this transaction, it is listed on a stock exchange and otherwise meets the conditions of the definitions of an MFT and an REIT of the Tax Act.
   
2. The CPC Program:⁶ As part of a Qualifying Transaction (“QT”) of a corporation under the Capital Pool Company (“CPC”) Program of the TSX Venture Exchange (“TSXV”). A QT is any transaction pursuant to which the resulting entity (i.e., REIT) will meet the initial listing requirements of the TSXV as a Group 1 or 2 issuer for real estate entities. For the purposes of the ITA, certain conditions that must be met in order to become an MFT and an REIT.⁷Previously, a CPC was invariably a corporation and not a trust. Prior to the TSXV’s policy change on the subject, to create an REIT, a company was used that:

1. • was a corporation that was listed on the stock exchange as part of the TSXV’s CPC program. Since an REIT is a trust, the CPC, a corporation with no shares, had to convert to a trust, which was done as part of its QT by way of a plan of arrangement. The CPC then became a trust and acquired a real estate portfolio that generally included one or more significant concurrent financing methods to meet the TSXV’s initial listing requirements and the Tax Act’s definitions of an MFT and an REIT. In addition, it had to demonstrate its ability to make distributions and achieve the growth required by REIT investors.

3. A CPC Trust: An inter vivos trust that will become an MFT and REIT upon its QT may, under certain conditions, be directly listed on the TSXV under the TSXV Capital Pool Companies Program.⁸

In summary

An issuer listed on the TSXV may therefore be a trust that will be a CPC, as well as an MFT and an REIT, following its QT. This avoids the costly and complicated plan of arrangement required to convert a corporation to a trust.

In general terms, by using the TSXV CPC program, an REIT, which is primarily a commercial inter vivos trust, can be created by taking the following steps:

1. Formation and stock exchange listing of a CPC-Trust
   
   • Subscription by the founders to shares in a new trust issued at a discount versus the units issued at the IPO, generally at a price equal to 50% of the price of the IPO shares. This step is completed at the instigation of the CPC’s promoter trustee(s).
     
   • Public offering by prospectus and public listing as a CPC-Trust. This step is the responsibility of an investment broker who will generally seek the support of the trustees.
2. Qualifying Transaction: Prior to the end of the 24-month period following the IPO, the trustees will have identified a building(s) and financing(s) (debt and equity) that will ensure that the trust meets the conditions for a regular TSXV listing and the terms of the MFT and REIT definitions in the Tax Act. It should also be in a position to make the future distributions expected by its beneficiary investors and have a value with modest growth.

This does not constitute a legal opinion or any opinion whatsoever on the topics discussed. Any such transactions should be completed with the assistance of a financial or legal advisor who is familiar with the subject matter.

1 122.1(1) Def. of a REIT according to the ITA.

2 Par. 132(6) ITA; Also known as single-level taxation or investor taxation. In comparison, the taxation of a corporation is a two-level tax system, that of the corporation and that of its shareholders. Herein, ITA refers to the Income Tax Act of Canada (“ITA”); (122(1)(b) and 104(16) ITA).

3 122.1(1) Def. “Real Estate Investment Trust” (“REIT”), which, by definition, is not a “SIFT trust” subject to the anti-conduit rule. Under this rule, the trusts or partnerships concerned are subject to income tax similar to those applicable to corporations. Thus, their beneficiaries or members who are subject to a tax treatment similar to that of the shareholders of a corporation. The anti-conduct rule does not apply to trusts that are REITs.

4 122(1)b) and 104(16) ITA, 122.1(1) ITA def. of “specified investment flow-through trust”.

5 122.1(1) Def. of ITA, paragraph e) ITA and 132(6) ITA, def. of an MFT, paragraph c), 4801 of the ITA Regulation.

6 Following it’s qualifying transaction (“QT”) of the trust should meet the conditions required for the trust to qualify as an MFT (132(6)(c) ITA and 4801 of the ITA Regulations) and as a “real estate investment trust” (122.1(1)(e) ITA). It will then benefit from the tax advantages of an MFT and will not be subject to the anti-conduct rule of the ITA.

This is the Capital Pool Companies Program of Policy 2.4 (“CPC”) of the TSXV Corporate Finance Manual (“Manual”). In this document, the abbreviation Pol. refers to one of the Guide’s policies.

You can either create your own CPC or use one that has already been set up and is looking for a QT.

Under this program, a company (in this case, a trust) is temporarily listed on the TSXV. Following its initial public offering, prospectus and TSX listing, it will have at least 200 public investors and will have 24 months to complete a “qualifying transaction” (“QT”). A QT is any transaction that ensures that the resulting entity will meet the usual listing requirements of the TSXV (Pol. 1.1(1.2); QT Def.)

Before the CPC is listed on the stock exchange, it must not be a party to an agreement in principle relating to its QT. If this were the case, it would not be able to use the CPC program to list on the TSXV (Pol. 2.4(2.5) (a)). There is an agreement in principle if the Board of Directors of the CPC and the other parties to a proposed QT project agree on all the fundamental terms of this transaction and no material conditions are imposed with respect to the closing of the QT that are beyond the reasonable control of persons not dealing at arm’s length with the CPC or persons not dealing at arm’s length who are parties to the QT.

Policy 2.4 states that there is no agreement in principle, among other things, whether the CPC’s QT will only take place if:

– significant conditions beyond the control of persons not dealing at arm’s length with the CPC must be met for the QT to take effect

– significant financing must be completed

– the amount of the consideration has not yet been agreed upon

– the QT is dependent on positive due diligence, or

– an important condition must be met before the transaction takes place (Pol. 2.4(2.6).

Shares issued at a discount to the founders of the CPC prior to the IPO are subject to a restriction on their right of non-resale that extends the IPO over a period of time (“escrow” of Pol. 2.4(11) of the Guide).

⁷ The minimum initial listing requirements for a real estate sector entity in Group 2 of TSXV Pol. 2.1 requires it to:

– have net tangible assets of at least $2,000,000 or $3,000,000 in arm’s length financing

– have a significant interest in real estate

– have sufficient working capital and financial resources to carry out its business plan for 12 months and $100,000 unallocated

– have a float (public shares without restriction on resale) of at least 500,000 shares (each shareholder has $1,000 shares), 200 shareholders of the public (which its IPO provides) without restriction on resale and 20% of the issued and outstanding shares are held by public shareholders

Other conditions apply. It should be noted that the TSXV may require by exercising its discretion.

As for what a Group 1 or Group 2 entity means, the TSXV Guide specifies:

“1.2 Distinctions between groups and their sectors of activity:

a) Group 1 is the first group on the exchange; it is reserved for the most advanced exchange issuers with the most significant financial resources. Group 1 issuers benefit from reduced filing requirements and higher service standards. Group 2 includes the majority of listed issuers who trade their securities on the exchange.” (Pol. 2.1 (1.2) (a)).

8 Note that if the CPC trust does not become an MFT that is an REIT within the context of its QT under Policy 2.4(12.1), its other use may be limited. Indeed, policy 2.4(12.1) states that:

“(e) The resulting issuer may not be a financial services company, financial institution, financial services sector issuer or collective investment organization, as defined in securities laws;”

If the trust does not become an REIT, it may be required to convert to a corporation, which may be costly, both legally and fiscally.