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21 July 2008

Al Hudec on New Rules for income Trust Conversions

By Al Hudec, Partner On July 14, 2008, the federal Department of Finance released a discussion draft of new rules to facilitate the tax efficient conversion of an income trust to a public corporation. To date, such conversions have proceeded by way of taxable unit-for-shares exchanges, or pursuant to the cumbersome elective provisions of s. 85(1) of the Income Tax Act. There has been no effective tax deferred method of winding up an income fund. Under the proposed rules, s. 85.1 will be revised to provide for an automatic tax-deferral for unit-for share exchanges, provided that unitholders receive no consideration other than shares of a single class, and that the fair market value of the shares received equals the value of the units. Under the new rules, an income trust can be wound up either under new s. 107(3.1) which permits an income fund to distribute the shares of a Canadian controlled subsidiary corporation which is its only assets to its unitholders; or under new s. 88.1, which provides a winding up mechanism for trusts similar to the section 88(1) mechanism for winding up a corporation. The new rules are likely to have little impact on the timing of trust conversions. Trusts which are deferring conversion to maximize the value of their current exemption from entity level taxation before the imposition of tax in 2011 are likely to continue to do so. Some trusts, such as those whose distributions consist principally of return of capital or foreign source income, as well as those which have significant tax pools with which to shelter taxable income, are likely to delay conversion until the end of 2012 which is the deadline for converting using the new rules. Similarly, income funds that remain hopeful of selling to a private equity or pension fund buyer are likely to wait rather than convert now. Once enacted, the new rules will simplify income trust conversions as well as share-for-unit corporate takeovers of income trusts. The new rules will benefit trusts which wish to convert now rather than when the trust tax is imposed in 2011. Reasons to convert early include: (i) access to capital markets; (ii) avoidance of the “normal growth” rules and the mutual fund rules limiting foreign ownership to 50%; and (iii) the desire to forego regular distributions and to devote cash to growth endeavours. Please click below for a more complete analysis of the new income trust conversion rules or contact Al Hudec or .(JavaScript must be enabled to view this email address). Download the PDF file here.

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