The federal government, which turned the REIT world on its ear six years ago with its rule changes to how income trusts would be taxed – dubbed the “Halloween massacre” – recently announced a third round of rule adjustments designed to deal with the unique requirements of the REIT world in the wake of that big change.
“This pretty much fixes everything that was on our shopping list,” said Michael Brooks, a real estate lawyer with Aird Berlis of Toronto. “From the industry’s point of view, we are really happy with it.”
Brooks noted that the changes in this third round of revisions, which are part of a series of tax amendments introduced by the Department of Finance, addresses more details than “the big picture stuff.”
He identified a number of broad areas that were dealt with by the changes.
The first is what he called the “Tim Hortons pad problem.” He gives the example of a retail REIT, such as RioCan, which has an expansive parking lot that the coffee chain wants to place a kiosk on – and own the real estate underneath it. That’s an arrangement that did not conform with the old rules. “Because you were going to sell it, it is inventory and that was a no-no,” he explained. “So they fixed that and they have allowed us that under what they call eligible resale property. So that is really a big win for our retail REITs.”
Changes make dollars and sense
Ottawa also addressed the problem real estate companies encounter when they do an IPO for a new REIT or conduct a significant financing. “You get all this cash and you put it in the bank, and having it in the bank was a bad asset and interest income was a bad asset, so you are instantly offside,” said the lawyer. “So we had to fix the situation where you had cash and hadn’t yet bought buildings but you were out shopping. So that is fixed as well.”
Ottawa carried out a similar fix with regard to hedging revenues, which were also classified as “bad” revenues under the old regime. That previous issue affected REITs that had assets in the United States and wanted to hedge the currency or those that may have had assets in Canada but wanted to hedge interest rates. Any gains under those schemes were classified previously as bad income, said Brooks.
Ottawa has worked in this third “fix” and the one of a year ago to expand the basket of permitted bad assets and permitted bad income which had proved to be a headache for REITs since the initial changes to REITs in 2006.
Finally, Ottawa has made rule changes to deal with the complicated corporate structures of the real estate industry. “A lot of these REITs have really complicated corporate structures with subsidiary nominee companies and limited partnerships, so you had to go through the rules and apply them to each entity in your empire to make sure that they were onside, complied with the rules and wasn’t accidentally caught,” explained Brooks. “So there has been a number of fixes to really acknowledge the fact that a lot of REITs are organized in a pyramid with separate nominee corporations owning each individual asset.
“These rules basically bring everything in the umbrella onside,” he concluded.