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11 May 2004
As expected, proposals in the recent budget will affect the taxation of interests in income trusts. This update outlines the areas where these proposals will have the greatest impact.
The budget proposes two measures to limit the level of investment that a pension
fund(1) can place in business income trusts. Pension funds will be required to
pay a penalty tax on their holdings of (i) interests in business income trusts
(including units and debt) in excess of 1% of the cost amount of the pension
fund's assets (the penalty tax will apply to direct and indirect holdings through
certain pass-through entities, such as a mutual fund trust); and (ii) more
than 5% of the units of any single business income trust.
In each case, the amount of the penalty tax will be 1% of the excess, per month.
Pension funds that currently have investments in business income trusts will
be given transitional relief. Existing investments in business income trusts
(ie, investments owned before March 23 2004) will not be subject to the penalty
tax, but will be taken into account in determining the extent to which further
investments can be acquired before reaching the limitations. The transitional
relief for existing direct holdings in business income trusts will last for
10 years (ie, to the end of 2013), and the transitional relief for indirect
holdings will last for five years (ie, to the end of 2008). The penalty taxes
will start to apply for months that end after 2004.
In general, non-residents are taxed in Canada on gains realized when they dispose
of taxable Canadian property.(2) However, non-residents that invest in Canada through
mutual funds are not generally taxed in Canada on these gains. Distributions
made to non-residents that represent capital gains realized by a mutual fund
trust are currently not subject to withholding tax, including in respect of
capital gains on taxable Canadian property. In addition, distributions made
to non-residents that represent a return of capital are not subject to withholding
tax. The budget proposes the following measures to deal with these types of
Currently, an anti-avoidance rule disqualifies a mutual fund trust from having
this status if, in general: (i) it is established or maintained primarily for
the benefit of non-residents; and (ii) more than 10% of the fund's property
consists of taxable Canadian property. For the purposes of this rule, the definition
of 'taxable Canadian property' does not include Canadian resource properties
and timber resource properties. The new proposals provide that such properties
will now be treated as taxable Canadian properties for the purposes of the 10%
threshold. A transitional rule provides that mutual fund trusts affected by
this change will have until January 1 2007 to comply with the modified rule.
The Department of Finance indicated that it will continue to evaluate the development of the income trust market as part of its ongoing monitoring and assessment of Canadian financial markets and the Canadian tax system. This serves as a warning that further changes in this area are possible.
For further information on this topic please contact Corrado Cardarelli or Catrina Card at Torys LLP by telephone (+1 416 865 0040) or by fax (+1 416 865 7380) or by email (email@example.com or firstname.lastname@example.org). The Torys website can be accessed at www.torys.com.
(1) 'Pension funds' include registered pension plan trusts, registered pension plan corporations and tax-exempt pension investment corporations, but do not include registered retirement savings plans, registered retirement income funds, deferred profit-sharing plans or registered education savings plans. Generally, 'business income trusts' include all income funds that indirectly own entities that carry on businesses—with certain exceptions, including a primary one for trusts structured as resource royalty trusts or real estate investment trusts (being trusts for which 90% or more of the fair market value of their properties is attributable to resource property or real property).
(2) 'Taxable Canadian property' includes, among other things, real property situated in Canada, shares of the capital stock of private corporations and an interest in a partnership if more than 50% of the value of the partnership's property is attributable to taxable Canadian property. In some circumstances, Canadian resource property and timber resource property are also treated as taxable Canadian property.
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