On October 31, 2006, the federal government announced proposals to introduce a new tax regime for certain publicly traded trusts and partnerships ("specified investment flow-throughs" or "SIFTs") which will essentially treat such entities like corporations and tax their investors like shareholders. According to various reports, the impetus for the proposals was the government's increasing concerns over the loss of tax revenue, the shift of the income tax base from corporations to investors and the harm to national competitiveness that may result from the dramatic growth of income trusts in the Canadian marketplace.
The new rules will not apply until 2011 for existing SIFTs. New SIFTs that begin to be publicly traded after October 2006 will be subject to the new regime in 2007. A SIFT generally will include a conventional income trust but not a real estate investment trust.
According to the government, "tax rules that were designed essentially for non-commercial and portfolio investment trusts (and for owner-operated partnership businesses) are being used by large-scale business entities that are widely held and publicly-traded, and the results are not appropriate."
Under the proposed rules, a SIFT will be subject to tax at general corporate tax rates on business income and certain other income distributed to investors. Distributions of such income will be taxed to the investor as taxable dividends received from a Canadian corporation. The new rules will not affect distributions that are returns of capital.
In effect, the main targets of the proposed rules are non-resident investors and tax-exempt investors (such as RRSPs). Under existing rules, income distributions paid to a tax-exempt investor are not subject to tax at the SIFT or investor level and income distributions paid to non-resident investors are subject only to a withholding tax. Under the proposals, the after-tax return to such investors will be reduced by approximately 1/3 (one-third). The after-tax returns to individuals resident in Canada should not change as a result of these proposals.
The government analogized its new rules to changes previously made to the taxation of flow through entities ("FTEs") in the U.S.A. and Australia, saying that both of those countries "have foreclosed the kind of inappropriate avoidance of entity-level tax that Canada's FTEs now exploit."
Although no draft legislation has yet been released, the government indicated that, if necessary, it will consider anti-avoidance rules to ensure that its policy objectives are met and to prevent, among other things, an existing SIFT from unduly expanding during the four-year transition period. This anti-avoidance caveat could prevent a SIFT, for example, from acquiring assets from non-SIFTs but should not prevent existing SIFTs from consolidating.
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