CRA rules on the non-application of SIFT tax to REIT’s subsidiary LP issuing exchangeable units to tax-exempt

A REIT (i.e., a listed unit trust qualifying as a REIT for ITA purposes) indirectly purchased a property from a Canadian-resident tax-exempt corporation on the basis that such vendor would effectively take back a convertible preferred share for part of the purchase price. This was accomplished by an affiliate of the vendor, which was also a tax-exempt resident corporation (the “Vendor Affiliate”), subscribing for preferred units of a newly formed subsidiary limited partnership (“New LP” – the property purchaser), which was held directly and indirectly by the REIT.

The preferred units bore a fixed per-unit distribution entitlement on their face amount and were exchangeable, based on a largely fixed exchange ratio, at the option of the Vendor Affiliate into REIT units. At the closing time, the FMV of the REIT units, into which the preferred units were exchangeable, was substantially lower than the face amount of the preferred units. Furthermore, the purpose of the preferred units’ exchange rights is stated to be “not to create an instrument that replicates the return on or value of a … REIT Unit.”

CRA ruled that the holding of the preferred units by the Vendor Affiliate would not cause New LP to be a SIFT partnership. This ruling turned on the proposition that the preferred units did not represent “investments” in a publicly-traded entity, i.e., the REIT. The s. 122.1 “investment” definition relevantly refers to “a right that may reasonably be considered to replicate a return on, or the value of, a security of the trust.” The CRA summary simply states that this was not the case “because there is no replication.”

There was no blandishment that New LP was an “excluded subsidiary entity,” which would have depended on satisfying the more onerous test that the preferred units were not “property, the value of which is determined, all or in part, by reference to a security that is listed or traded on a stock exchange.”

The terms of the preferred units contemplated that, to the extent possible, the annual allocations of taxable income thereon would represent the same proportion of the distributions thereon as for the REIT units. It was stated that this was “intended to provide assurance that the [transactions] … have not been … entered into to circumvent subsection 104(7.1).”

Neal Armstrong. Summary of 2024 Ruling 2023-0997921R3 under s. 122.1(1) – investment – (a)(ii).