Canada’s Department of Finance last Friday gave additional guidance to income trusts and other flow-through entities on what it considers permissible “normal growth” with respect to new tax measures announced on Oct. 31 (see Daily GPI, Nov. 2).

In October, Minister of Finance Jim Flaherty announced a “tax fairness plan” that includes a tax on certain amounts distributed by a “specified investment flow-through” (SIFT) trust or SIFT partnership. The tax applies as of 2007 to new entities but is deferred until 2011 for SIFTs that were publicly traded as of Oct. 31.

The deferred application of the tax is, however, conditional on existing SIFTs respecting the policy objectives of the proposals. Materials released with the announcement indicated that, for example, the undue expansion of an existing SIFT might cause the deferral to be rescinded. On the other hand, the continuation of the normal growth of a SIFT would not raise concerns.

The department has now provided existing SIFTs with more detail as to what is meant by “normal growth.” The department’s guidance has been prepared following consultations with many publicly traded trusts and partnerships and is based on its observations as to the range of growth arising in the normal course of business. Specifically, the department will not recommend any change to the 2011 date in respect of any SIFT whose equity capital grows as a result of issuances of new equity by an amount that does not exceed the greater of $50 million and an objective “safe harbor.”

The safe harbor amount will be measured by reference to a SIFT’s market capitalization as of the end of trading on Oct. 31, 2006. Market capitalization is to be measured in terms of the value of a SIFT’s issued and outstanding publicly traded units. For this purpose, it would not include debt (whether or not that debt carried a conversion right or was itself publicly traded), options or other interests that were convertible into units of the SIFT.

For the period Nov. 1, 2006 to the end of 2007, a SIFT’s safe harbor will be 40% of that Oct. 31, 2006 benchmark. A SIFT’s safe harbor for each of the 2008 through 2010 calendar years will be 20% of that benchmark, together allowing growth of up to 100% over the four-year transition period.

In addition, the following clarifications were made:

Consistent with the objectives of tax fairness plan, the Department of Finance will monitor developments in the market and will take action accordingly to ensure that this guidance is respected.

It is intended that conversions of a SIFT to a corporation be allowed to take place without any tax consequences to investors on the conversion. The department has received a number of representations concerning the rules applying on the conversion of a SIFT to a corporation, and is examining whether any impediments to conversion exist under the current income tax rules. If so, changes will be recommended to ensure that appropriate rules are in place to facilitate such conversions.

Prior to Oct. 31, companies largely ceased to be taxable if they converted to a trust and their shares became investment units. The critical ingredient of such conversions was commitments to pay unit owners, as distributions, most of company’s cash flow. The trust structure has been particularly popular in Canada’s energy patch, and some see the tax rule change as not necessarily a bad thing (see Daily GPI, Nov. 3).

In November Calgary-based Pengrowth Energy Trust announced the acquisition of Canadian oil and gas properties and undeveloped lands (the “CP properties”) from ConocoPhillips for nearly C$1.04 billion (US$914 million). At the time, the income trust said that it had received a “comfort letter” from Canada’s department of finance advising the company that its acquisition of the CP properties likely would not trigger an acceleration of any tax rule change as would be possible in the case of “undue expansion” (see Daily GPI, Nov. 30).

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