REIT Ancillary Issues April 2009

Transcription

1 April 2009 One University Avenue, Suite 1410 Toronto, Ontario Canada M5J 2P1 T: (416) F: (416)

2 Page 2 REALpac represents Canadian REITs, a multi-billion dollar segment of the public equity capital markets. The Canadian market for investment grade real estate has been estimated at $400 billion. REALpac members own in excess of $150 billion of that total, or more than 30% of real estate assets located in the major centres across Canada. Assets include retail, office, industrial, hotel, multi-residential (apartments) and seniors housing. We also count as REALpac Members, publicly traded and large private companies, banks, brokerages, crown corporations, investment dealers, life companies and pension funds who own investment real estate. Our perspective is therefore that of the several types of entities that hold investment real estate in Canada, not only the REITs. REITs are most likely the original, and certainly the most popular flow-through entity, providing the equivalent of direct ownership interest for individuals in big ticket, income producing real estate assets around the world. REITs currently exist in 29 countries and are in the advanced stages of planning in several others. In each case, the fundamentals are the same; as long a defined percentage of taxable income is distributed to unitholders, there is no tax levied on the trust. Our main trading partner, the U.S., has had REITs (indeed, a flow-through corporate vehicle) for 45 years. REITs are specifically statutorily enabled under section 132(6) of the Income Tax Act, an amendment made in 1994 specifically to allow real estate mutual fund trusts to become listed on a prescribed stock exchange. This amendment added real estate to the list of prescribed eligible investments for mutual fund trusts and unit trusts. REITs enjoy favourable treatment around the world and currently, in Canada, because: REITs are passive assets that could be held directly by investors; REITs allow average investors to own big ticket, income producing real estate on the same basis as wealthy investors; and The asset class, income producing real estate, is appropriately suited to a flow through vehicle because of its stable, reliable income stream. On October 31 st, 2006 the Department of Finance announced new rules applicable to business income trusts. REITs were exempted, but only if they met certain tests modelled partially on the US REIT rules. We appreciate the continuing recognition of the global nature of the REIT vehicle in Canadian tax policy. We also appreciate the efforts of government officials to ensure that Canadian REITs remain competitive. However, there are still outstanding policy and technical concerns with the current REIT rules. In particular, there has been considerable discussion among our Members regarding the meaning of the term ancillary in the current REIT rules. The term ancillary property is found in the definitions of real and immovable property and qualified REIT property and the term ancillary service is found in the definition of rent from real or immovable properties. Ancillary is not defined in the Income Tax Act. In the explanatory notes released by the department of federal finance in June 2007 related to the Budget Implementation Act 2007, the following information is provided related to the word ancillary :

3 Page 3 Under qualified REIT property The fourth type is property that is ancillary to the earning by the trust of rent from real or immovable properties and capital gains from dispositions of real or immovable properties. For example, a REIT can hold office furniture and computers that are ancillary to its operations. Under real or immovable property Third, only certain depreciable property is included in the definition. Depreciable property that is included is (i) a property included (otherwise than by an election) in Class 1, 3, or 31 of Schedule II to the Income Tax Regulations, (ii) a property ancillary to the ownership or utilization of a property described in (i), or (iii) a lease in, or a leasehold interest in respect of, land or property described in (i). Property ancillary to the ownership or utilization of, for example, a building in Class 1 could be a parking lot, a fence, or a solar panel. Under rent from real or immovable properties Rent from real or immovable property is defined to include rent or similar payments for the use of, or right to use, real or immovable properties and payment for services ancillary to the rental of real or immovable properties and customarily supplied or rendered in connection with the rental or real or immovable properties. Examples of services that are ancillary and customarily supplied or rendered in connection with the rental of an office tower could be concierge services, after-hours HVAC or; for the rental of a residential building, could be coin operated washing machines or snow removal; but would not include any form of nursing or medical care. Please see the KPMG document attached as schedule A, REIT Rules and the Meaning of Ancillary for additional background on attempt to define the word ancillary. We request a ruling on each of the fact patterns with respect to the meaning of ancillary property for qualified REIT property and real or immovable property in the following circumstances: 1. Parking 1.1 Under real of immovably property, a REIT may own a parking area associated with a building. There are a number of variations of parking area ownership by the REIT and the resulting income listed below that we are seeking to clarify. In each scenario, we would like to know if the parking area is deemed ancillary property. A REIT owns a parking area and earns parking income from its residential and/or commercial tenants. The nature and source of parking income tends to vary from property to property. Will the parking area be deemed ancillary in the situations below?

4 Page 4 i. Standalone residential building (including surface or underground parking), where tenants of the building pay a flat monthly rent for a designated parking spot. ii. Standalone residential building (with adjacent/standalone parking garage). The parking garage is managed by a third party parking company. Residential tenants in the building pay monthly parking for their designated spot. In addition, the parking operator rents the parking spots to outsiders from neighbouring buildings and/or adjacent facilities. iii. iv. Combination of the where the REIT, as manager of the building, rents out in some cases surplus parking spots to commercial tenants and outsiders. The REIT as the leasehold interest holder, has an interest in a parking garage (jointly used by retail and office complex) where the REIT has access to specified, unreserved parking spaces for its tenants, with the remaining space available to the general public. A REIT as the leasehold interest holder, is entitled to a proportionate share of the either gross revenue or net revenues from the operation of the parking garage. The parking garage may be managed by the landlord or by a third party operator. 1.2 Is a parking area described in Class 17, on land adjacent but owned by the REIT to a building owned and operated by the REIT, ancillary to the ownership or utilization of the building and therefore qualified REIT property, if: i. 100% of the parking lot spaces are used by tenants in the building? ii. iii. iv. All or substantially all (generally 90% or more) of the parking lot spaces are used by tenants in the building? More than 50% but less than 90% of the parking lot spaces are used by tenants in the building?; or Less than 50% of the parking lot spaces are used by tenants in the building? 1.3 Is a parking area described in Class 17, on land adjacent to a building and leased by the REIT to a third party operator, ancillary to the ownership or utilization of the building and therefore qualified REIT property, if: i. 100% of the parking lot spaces are used by tenants in the building? ii. All or substantially all (generally 90% or more) of the parking lot spaces are used by tenants in the building?

5 Page 5 iii. iv. More than 50% but less than 90% of the parking lot spaces are used by tenants in the building?; or Less than 50% of the parking lot spaces are used by tenants in the building? 1.4 Are there any other criteria in assessing whether a parking lot is "ancillary" to the ownership or utilization of a building? 1.5 Is parking a service and, if so, is revenue from parking rent from real or immovable property as "payment for services ancillary to the rental of real or immovable properties? 1.6 Are items of personal property (e.g. uniforms, furniture and fixtures, computers, portable kiosks) used in the parking lot operations if they are ancillary, ancillary to the earning of rent from real properties and therefore qualified REIT property? Ancillary Fact Patterns Parking Areas Document Property Type Reference Number Parking Areas 1.1 (i) Standalone Residential Building 1.1 (ii) Standalone Residential Building with adjacent standalone parking garage 1.1 (iii) Standalone Residential Building 1.1 (iv) Office and Retail Complex Ownership of the Parking Area REIT REIT but managed by a third party parking company REIT REIT as leasehold interest holder has an interest in the parking garage Income Tenant Pays Flat Monthly Rent for Parking Tenants and outsiders pay a monthly fee Tenants pay a monthly fee, some surplus parking spots rented to commercial tenants and outsiders The REIT has access for its tenants with the remaining space available to the general public The REIT is Ancillary? Y/N

6 Page 6 Document Reference Number Property Type 1.2 (i) Parking area described in Class 17, on land adjacent to a building owned and operated by the REIT Ownership of the Parking Area Owned and operated by the REIT 1.2 (ii) Same as 1.2 (i) Same as 1.2 (i) 1.2 (iii) Same as 1.2 (i) Same as 1.2 (i) 1.2 (iv) Same as 1.2 (i) Same as 1.2 (i) 1.3 (i) Parking Lot Described in Class 17, on land adjacent to a building and leased to a 3 rd party operator REIT 1.3 (ii) Same as 1.3 (i) Same as 1.3 (i) 1.3 (iii) Same as 1.3 (i) Same as 1.3 (i) 1.3 (iv) Same as 1.3 (i) Same as 1.3 (i) 1.4 Are there any other criteria in assessing whether a parking lot is ancillary? 1.5 Is parking a paid service and if so, is revenue for parking rent from real or immovable Income entitled to a proportionate share of either gross revenue or net revenues from the operation of the parking garage 100% of the parking lot spaces used by tenants in the building All or substantially all (90% or more) of the spaces used by tenants More than 50% but less than 90% used by tenants Less than 50% of the spaces used by tenants 100% of spaces used by tenants in the building All or substantially all of the spaces (90% or more) used by tenants More than 50% but less than 90% used by tenants Less than 50% used by tenants Ancillary? Y/N

7 Page 7 Document Property Type Reference Number property as payment for services ancillary to the rental of real or immovable property? 1.6 Does property used in the parking lot operations such as uniforms, furniture and fixtures, computers, etc qualify as ancillary? Ownership of the Parking Area REIT Income N/A Ancillary? Y/N Are each or any of these scenarios ancillary property for the descriptions provided in the REIT rules? 2. Title Subsidiaries/Nominee Corporations A situation may arise where a nominee holds shares of a bare trustee or multiple bare trustees that hold title to the REIT s real property (i.e., a two-tier nominee structure). The entities have no other activities, and as such it should be clarified that these are also qualifying REITs. Other areas of the rules allow for multi-tiered structures and we request that this be allowed for title subsidiaries. Is the nominal cash paid to a bare trustee corporation for the issuance of shares "ancillary" for the purpose of the definition of qualified REIT property? 3. Loans, Mortgages and Deposits 3.1 Mortgages Receivable A REIT may offer a mezzanine financing arrangement to an arm s length developer to establish a pipeline to acquire properties. This financing enables a developer to acquire and/or develop an asset in which the REIT has an option at the outset to acquire a partial or 100% interest upon completion. The completed development becomes a stable income producing real estate asset for the REIT. The asset in question normally serves as security, which may be enhanced by the developer s covenant or a charge on another property. Interest may be paid out in cash monthly, or it may accrue on the loan, depending on the particular arrangement. While the REIT has the express intention of acquiring an interest in the property at the time of making the loan, occasionally the option is not exercised because of changes in the market, additional adverse information that becomes available as the development progresses, or other adverse business reasons. Under the current SIFT legislation, a loan made to an entity in an amount which represents more than 10% of the equity value of that entity is a Non-Portfolio

8 Page 8 Property. This threshold would often be exceeded in the real estate industry, where single purpose entities are frequently used. Mortgages receivable would only be considered Qualified REIT Property ( QRP ) if they are real or immovable property or property ancillary to the earning of rental income or capital gains in respect of real or immoveable property. They would normally not meet the test of real or immovable property since the borrowers are developers who do not qualify as REITs themselves because they do not hold their real estate assets as capital properties. The question arises as to whether a mortgage loan can be considered property ancillary to the ownership or utilization of real or immoveable property, or whether it is an asset that is ancillary to its operations. Since the sole purpose of making the loan is to own real property, it could be viewed as subordinate to the ownership of that property, or to its main business, which is the earning of rent from real properties. It should be pointed out that mortgage interest income is allowed as good revenue in both the 75% and the 95% REIT income tests. Is mezzanine loan financing provided to a developer to facilitate the construction of real property to be acquired by the REIT, "ancillary" for the purpose of the definition of qualified REIT property? 3.2 Vendor Take-Back Mortgages A vendor take-back mortgage ( VTB ) is extended in order to facilitate a sale by the REIT where it is a condition of the transaction. Since the VTB is required by the purchaser to complete the transaction, the resultant capital gain earned on the sale by the vendor is directly dependent on making the VTB. The VTB can be viewed as auxiliary to the earning of capital gains on real or immoveable property, since the purpose of holding the VTB is strictly to earn that type of income. There may be situations where a VTB is given and a capital loss not specifically referred to in the revenue tests - is realized by the vendor, for example, where an asset is divested for strategic reasons. In this case the VTB could still be considered ancillary to the business of earning rental revenue and capital gains, since the capital from the sale will be presumably used elsewhere to enhance these types of revenue-earning activities. Is a mortgage taken back as consideration in connection with the sale of land and buildings, ancillary to the earning of the capital gain from the disposition of real or immovable properties and, therefore, qualified REIT property, if: i. The mortgage was receivable from a non-canadian entity?

9 Page 9 ii. The mortgage was receivable from a subject entity but represented 10% or less of the equity value of the debtor? iii. The mortgage was receivable form a subject entity and represented greater than 10% of the equity value of the debtor? Where a REIT provides a guarantee to facilitate a sale of one of its properties (e.g. a lender will not allow the existing mortgage on the property to be assumed by the purchaser unless the REIT guarantees the indebtedness) and such guarantee is called upon, the REIT will, upon payment under the guarantee, take over the position of the lender (i.e. the purchaser of the property will then be indebted to the REIT). Would the receivable resulting in such circumstances be qualified REIT property as "ancillary" to the earning of rent from, or capital gains from the disposition, of real or immovable properties? 3.3 Loans to Tenants The discussion of tenant loans is similar to vendor take-back mortgages. Loans to tenants may be made as a result of unforeseen financial difficulty, in order to keep the tenant and (eventually) obtain the rent that is due to the REIT. Since the earning of rent from this tenant is expected to be dependent upon making the loan, it could be viewed as ancillary, and subordinate to the rental revenue. Is tenant indebtedness arising from late rent payments or tenant inducement loans "ancillary" to the earning of rent from real properties and therefore qualified REIT property? 3.4 Non-Arm s Length Loans Many of the discussion points under Mortgages Receivable could apply to intercompany loans. Loans to non-arms length entities are common in the real estate industry, since many entities often form part of a REIT s structure for reasons of limited liability or compartmentalizing and third party borrowing requirements. These intercompany loans are used to provide funding to a particular subsidiary for the purchase and/or development of real estate. These loans may or may not be mortgages. If they are not secured by real estate, while the interest qualifies under the 95% good revenue test, it would not qualify under the 75% test (which specifically refers to mortgage interest). These loans allow for entities that are subsidiary to the REIT to hold the real estate on behalf of the REIT, for various business reasons as mentioned. The entities may be trusts, corporations, or partnerships, and may be lower than

10 Page 10 second-tier in the organization structure. Since the making of the loans is strictly to acquire real estate to earn rental revenue, these loans (which are eliminated when preparing consolidated financial reporting) should be considered ancillary to the REIT. 3.5 Deposits Are deposits for the purchase of rental real property: i. Real or immovable property? ii. iii. Ancillary to the earning of rent from real properties or capital gains from the disposition or real property, if the deposit represented 10% or less of the equity value of the vendor? Ancillary to the earning of rent from real properties or capital gains from the disposition of real property, if the deposit represented more than 10% of the equity value of the vendor? 4. Other 4.1 Cable Contracts: A REIT has entered into various agreements with cable service providers to allow the service provider to install equipment and to sign-up tenants (typically in an apartment building) for their cable television, telephone and internet services. The REIT receives compensation for the access to tenants based on a percentage of revenue earned by the service provider. The REITs believe that the nature of the compensation earned is primarily related to the business of renting apartments and providing its tenants with commercially required services (i.e. cable TV). Is such income rent from immovable property as payment for services ancillary to the rental of real or immovable properties? 4.2 HVAC / Component Systems Certainly boiler systems, A/C systems, sprinkler systems, fire pumps, alarm systems, signage (wayfinding and advertising, pylon signs, building signs), exterior lighting, parking lot control systems (gates, card readers, etc.), elevators, escalators, window cleaning swing stages and tiebacks, etc. are component parts of a building. For greater certainty, are all these component systems of a building considered real or immovable property? Is any property appurtenant to the operation or aesthetics or maintenance of a building considered real or immovable property or qualified REIT property?

11 Page Fitness Facility An office building may contain a fitness facility for its tenants, which would likely enhance the marketability of the building and therefore its ability to earn rental revenue. Since this amenity revenue would be immaterial relative to the REIT s qualifying revenues, if necessary it would very likely fit into the 5% basket of nonqualifying revenue, and not cause the REIT to be offside. Is the real property devoted to the fitness centre qualified REIT property? Is the depreciable property represented by the fitness equipment, furniture and other equipment necessary to operate the fitness facility, real or immovable property and/or qualified REIT property? 4.4 Ancillary Services Are the meals, laundry services, housekeeping services and/or light care (assistance with medication) services embedded in the terms of a real property lease and provided to tenants in a retirement residential real property, ancillary to the earning of rent from real property? In general, are additional services provided to tenants ancillary to the earning of rent from real property, if such services were provided without profit or loss? Is the cleaning of tenants rented space for a fee ancillary to the rental of real or immovable property for the purpose of the definition of rent from real or immovable properties? 4.5 Government Subsidies Are government subsidies granted to certain real estate operators for certain operating costs (eg. property tax) or certain capital expenditures (eg. green or energy saving initiatives) and earned in the operation of a real property rental portfolio considered rent from real or immovable properties? 4.6 Guarantee and Financing Fees Are guarantee fees earned from guaranteeing the obligations of a joint venture partner, rent from real or immovable properties as ancillary services? Are financing fees earned to secure financing on a joint venture property that is capital property, rent from real or immovable properties as ancillary services? 5. Clarification of the Qualified REIT Property Definition Paragraph (d) of the definition of qualified REIT property states that the property must be ancillary to the earning by the trust of rents and capital gains from real or immovable property. Can the "and" be read as "or"?