H&R REIT -- summary under Releveragings

Overview

The units of the REIT are stapled to those of Finance Trust. Finance Trust holds notes of the indirect U.S. subsidiary of H&R REIT (“U.S. Holdco”). Finance Trust is intended to qualify as a fixed investment trust for Code purposes, so that its unitholders are treated as if they held such notes directly. This avoids the U.S. earnings stripping limitations on the level of permitted interest deductions by U.S. Holdco as well as to a significant extent accessing the U.S. portfolio interest exemption from U.S. withholding tax. U.S. acquisitions by U.S. Holdco were funded with loans from H&R REIT. In order that much of this additional debt can access the benefits of the stapled structure, the REIT and Finance Trust are proposing an Alberta Plan of Arrangement under which Finance Trust will make a s. 107.4 transfer of its notes of U.S. Holdco to the REIT and, following the replacement of those notes and some of the newer debt with amended notes, and the distribution to the unitholders of units of a new fixed investment trust with nominal assets (the “F17 Trust”), the amended notes will be transferred by the REIT under s. 107.4 to the F17 Trust. Thus, there will be a replacement stapled structure similar to what was there before, except that the new Finance Trust (F17 Trust) will hold more U.S. Holdco debt. The repayment of a “significant amount” of the existing loans owing by U.S. Holdco to H&R REIT through the issuance of the additional notes in amended form is anticipated to generate a significant FX gain, but not so as to produce a result which is out of line with 2016, when significant capital gains also were pushed out to the H&R REIT unitholders. Implementation of this Arrangement is conditional on receiving rulings from CRA.

Stapled structure

In 2008, the REIT undertook a reorganization to create Finance Trust and the Stapled Unit structure the purpose of which was to enable U.S. Holdco to replace all of its debt held by the REIT at the time with new debt beneficially held by the REIT's unitholders through Finance Trust. On October 26, 2017, 290,662,821 REIT Units, 9,500,000 Special Voting Units and 290,662,821 Finance Trust Units were issued and outstanding.

The REIT

An Ontario unit trust whose units (stapled to those of Finance Trust) are listed on the TSX. CRAL Class B Limited, an affiliate of Canadian Realty Advisors Limited (formerly H&R Property Management Ltd.) beneficially owns 9,500,000 Special Voting Units, representing 100% of the Special Voting Units, or 3.2% of the total combined REIT Units and Special Voting Units eligible to vote at the REIT Meeting.

Finance Trust

An Ontario unit trust unit trust whose units (stapled to those of the REIT) are listed on the TSX. Its only assets are cash and interest-bearing notes of U.S. Holdco.

F17 Trust

H&R Finance (2017) Trust, an open-ended limited purpose unit trust to be formed under the laws of the Province of Ontario pursuant to the Plan of Arrangement.

Benco

H&R GP Beneficiary Inc., an Alberta corporation wholly-owned by the REIT, whose principal asset is 100% of the beneficial interest in the general partner of Holdings LP (Holdings GP Trust).

Holdings GP Trust

H&R REIT Holdings GP Trust, a trust formed under the laws of Ontario, that is the general partner of Holdings LP and whose sole beneficiary is Benco.

Holdings LP

H&R REIT Holdings Limited Partnership, an Ontario limited partnership whose sole general partner is Holdings GP Trust and sole limited partner is the REIT.

U.S. Portfolio LP

H&R REIT U.S. Portfolio Limited Partnership, an Ontario LP is indirectly wholly-owned by the REIT and in which Holdings LP has a 99.99% limited partnership interest.

Portfolio LP

H&R Portfolio Limited Partnership, a Manitoba LP whose Class A LP units are held by an Ontario unit trust (H&R Portfolio LP Trust) of which the REIT is the sole beneficiary. Its exchangeable Class B LP units. ar held by third-party vendors. It (along with Finance Trust and the REIT) holds US Holdco Notes. The general partner of Portfolio LP is a Canadian inter vivos trust whose sole beneficiary is a Canadian corporation wholly-owned by the REIT.

U.S. Holdco

H&R REIT (U.S.) Holdings Inc., a Delaware corporation that is wholly-owned by U.S. Portfolio LP and that holds investments in U.S. LLCs and LPs.

Reasons for Arrangement

The REIT has had to use substantially more of its own capital (lent to U.S. Holdco) than funds borrowed by U.S. Holdco from third parties to fund U.S. acquisitions. As a result, the REIT is currently owed approximately US$800 million by U.S. Holdco. Interest rates have declined since 2008 and the interest rate on the U.S. Holdco Notes is now higher than the rate that could be obtained from third party lenders. As a result, the REIT Trustees believed that in the absence of a transaction, such as the Arrangement, the U.S. Holdco Notes would need to be refinanced and replaced with debt bearing a lower (market) interest rate. Lending by the REIT to U.S. Holdco to finance acquisitions has adverse tax consequences, in that the deductibility for U.S. income tax purposes of interest paid by U.S. Holdco to the REIT is subject to the earnings stripping rules, which defer a tax deduction for a portion of the interest paid. Once U.S. Holdco is not currently taxable as a result of its use of net operating losses from prior years, once those net operating losses are exhausted, it is expected that U.S. Holdco would be required to pay U.S. income taxes, thereby reducing cash available for distribution to Unitholders.

General targeted U.S. effect of Arrangement

The U.S. earnings stripping rules should not apply to interest paid by U.S. Holdco to F17 Trust and therefore, the interest payable by U.S. Holdco to F17 Trust under the Amended U.S. Holdco Notes should be fully deductible for U.S. income tax purposes.

General targeted Canadian capital gains effect of Arrangement

By implementing the Arrangement, both the existing U.S. Holdco Notes, and a substantial amount of other existing debt owed by U.S. Holdco to the REIT, would effectively be replaced with indebtedness of U.S. Holdco to a new trust, F17 Trust, under the amended U.S. Holdco Notes. It is anticipated that the replacement of such other existing debt with such notes (the “Amended U.S. Holdco Notes” will give rise to a capital gain for the REIT for Canadian tax purposes (based partly on the current Canadian-U.S. dollar exchange rate). Although such capital gain will be a material portion of its capital gains for 2017, even including such capital gain, the total capital gains of the REIT made payable to Unitholders in 2017 are expected to not exceed the capital gains of the REIT made payable to Unitholders in 2016. Provided that a favourable CRA Ruling is obtained, the REIT and Finance Trust believe that the Arrangement will occur on substantially a tax deferred basis to Unitholders resident in Canada.

Anticipated Canadian withholding tax effect of Arrangement

In addition, Non-Resident Holders who are residents of the U.S. may face an increased average rate of Canadian withholding tax on their New Stapled Unit distributions following implementation of the Arrangement. This is because it is expected that a higher proportion of total distributions will be comprised of distributions from F17 Trust (as compared to the proportion of total distributions historically comprised of distributions from Finance Trust). As is currently the case with distributions made by Finance Trust, it is anticipated that Canadian withholding tax of 25% of the gross amount of F17 Trust distributions to a Non-Resident Holder that is a resident of the U.S. will be withheld and remitted on account of non-resident withholding tax.

Plan of Arrangement

1. U.S. Holdco will pay to the REIT all accrued and unpaid interest owing on the U.S.-dollar loans previously advance to it by the RIET (the “Existing Loans”).
2. The REIT will transfer the “Transferred Portion” of the Existing Loans (i.e., the portion thereof not repaid (the “Repaid Portion” in 17 below) to Holdings LP as an additional capital contribution.
3. Holdings LP will transfer the Transferred Portion to U.S. Portfolio LP, also as an additional capital contribution.
4. The Existing Loans held by U.S. Portfolio LP will be amended, without novation, repayment or replacement, to provide that the aggregate principal amount thereof may, at the option of the payee upon notice to U.S. Holdco (the "Exchange Right"), be converted into common shares of U.S. Holdco at the Conversion Amount per share.
5. U.S. Portfolio LP will exercise the Exchange Right and will convert the Transferred Portion of the Existing Loans into 999 common shares of U.S. Holdco.
6. The REIT will establish F17 Trust and will subscribe for F17 Trust Units, equalling the number of issued and outstanding REIT Units, for an aggregate subscription price of $1,000.
7. U.S. Holdco will pay all accrued and unpaid interest owing on the U.S. Holdco Notes.
8. The U.S. Holdco Notes held by Portfolio LP will be distributed by it to Portfolio LP Trust as a return of capital on the outstanding Class A limited partnership units of Portfolio LP.
9. The U.S. Holdco Notes so acquired by Portfolio LP Trust will be distributed to the REIT, the sole beneficiary of Portfolio LP Trust, as a return of capital on the outstanding trust units of Portfolio LP Trust.
10. Finance Trust will pay out, as a cash distribution on the Finance Trust Units, the amount equalling its bona fide best estimate of its undistributed taxable income its taxation year terminating with its termination.
11. Finance Trust will pay all outstanding accounts payable.
12. In accordance with ITA s. 107.4, Finance Trust will transfer all of the U.S. Holdco Notes held by it to the REIT for no consideration by way of a "qualifying disposition" (the “Finance Trust Disposition”).
13. The holders of Finance Trust Units will transfer all of their Finance Trust Units to the REIT (the “FT Unit Acquisition”), with the aggregate purchase price of $1,000 being delivered to, and held by, the Depositary as agent on behalf of such former holders.
14. The REIT will transfer to such former holders all of the F17 Trust Units for an aggregate purchase price of $1,000.
15. Finance Trust will redeem all the issued and outstanding Finance Trust Units.
16. The U.S. Holdco Note Indenture will be amended to adjust the interest rate to a rate determined by the REIT and U.S. Holdco to be an arm's length rate.
17. U.S. Holdco will repay in full the Repaid Portion of the Existing Loans by issuing additional Amended U.S. Holdco Notes ("Repayment Amended U.S. Holdco Notes").
18. In accordance with s. 107.4, the REIT will transfer all of the outstanding Amended U.S. Holdco Notes to F17 Trust for no consideration by way of a "qualifying disposition" (the “REIT Disposition”).
19. All of the property and liabilities of Holdings GP Trust (including the general partner interest in Holdings LP) will be distributed to, and assumed by, Benco as the sole beneficiary of Holdings GP Trust.
20. Benco will be liquidated.

F17 Trust governance and holdings

F17 Trust will be governed by a board of trustees consisting of four Canadian-resident individuals. As settlor of F17 Trust, the REIT will retain the right to appoint one of the F17 Trust Trustees. The remaining Trustees will be independent and elected by the unitholders of F17 Trust. In order to qualify as a "fixed investment trust", F17 Trust generally may not acquire assets other than the Amended U.S. Holdco Notes or certain investments in cash or cash equivalents.

F17 Trust redemption right

Pursuant to the F17 Trust Declaration of Trust, a holder of F17 Trust Units will have the right to redeem its F17 Trust Units at any time on demand in consideration for a price per unit equal to the Canadian dollar equivalent of the principal amount of Amended U.S. Holdco Notes held by F17 Trust on the redemption date, divided by the number of outstanding F17 Trust Units immediately prior to the redemption date, subject only to the requirement that, unless an Event of Uncoupling has occurred, a holder of F17 Trust Units who tenders a particular number of F17 Trust Units to F17 Trust for redemption shall be required to also tender, at the same time, the same number of REIT Units to the REIT for redemption. The entitlement of a holder of F17 Trust Units to receive cash upon the redemption of F17 Trust Units is not applicable if the total amount payable by F17 Trust in respect of such F17 Trust Units and all other F17 Trust Units tendered for redemption prior thereto in the same calendar month exceeds a monthly limit, which may be waived by the F17 Trust Trustees. If a holder of F17 Trust Units is not entitled to receive cash upon the redemption of F17 Trust Units as a result of the foregoing limitation, the F17 Trust redemption price for each F17 Trust Unit tendered for redemption will be the fair market value thereof as determined by the F17 Trust Trustees and, subject to any applicable regulatory approvals, shall be paid out and satisfied by way of delivery of Amended U.S. Holdco Notes.

Amended U.S. Holdco Notes

The Amended U.S. Holdco Notes will mature on the tenth anniversary of the Effective Date, subject to U.S. Holdco's right to extend the maturity date one time for a ten-year period.…The Amended U.S. Holdco Notes will bear interest payable monthly at a floating rate adjusted monthly equal to the annual interest rate for ten-year U.S. treasury notes, determined as at the immediately preceding interest payment date, plus a fixed % per annum spread. F17 Trust will have a limited right to put Amended U.S. Holdco Notes to U.S. Holdco for repayment in cash prior to the maturity date, which put right may only be exercised by F17 Trust where a holder of F17 Trust Units has surrendered F17 Trust Units for redemption in order to permit F17 Trust to satisfy the redemption price for such units, or has exercised dissent rights, to satisfy a claim for fair value of such holder's F17 Trust Units.

Amended stapling provisions

The REIT Declaration of Trust will provide that: (a) each REIT Unit may be transferred only together with an F17 Trust Unit, (b) no REIT Unit may be issued by the REIT to any person unless an F17 Trust Unit is simultaneously issued by F17 Trust to such person and (c) a holder of New Stapled Units may require the REIT to redeem any particular number of REIT Units only if it also requires, at the same time, and in accordance with the provisions of the F17 Trust Declaration of Trust, F17 Trust to redeem that same number of F17 Trust Units. Equivalent provisions will be included in the F17 Trust Declaration of Trust.

Canadian tax consequences

REIT status

The REIT is expected to qualify for the REIT Exception for the current taxation year. In addition, management of the REIT intends to conduct the affairs of the REIT so that the REIT will qualify for the REIT Exception at all future times.

Finance Trust Disposition

A Resident Holder will not realize any taxable income or gain solely as a result of the Finance Trust Disposition in 12. It is expected that the fair market value of each Finance Trust Unit will be reduced to a nominal amount as a consequence of the Finance Trust Disposition, such that an amount approximately equal to the full amount of the adjusted cost base of a Resident Holder's Finance Trust Units will be added to the adjusted cost base otherwise determined of the Resident Holder's REIT Units in computing the adjusted cost base of such REIT Units immediately after the Finance Trust Disposition.

FT Unit Acquisition

Any such gain or loss to a Resident Holder on the FT Unit Acquisition will be nominal.

REIT Disposition

A Resident Holder will not realize any gain solely as a result of the REIT Disposition in 18. Immediately after the REIT Disposition in accordance with the qualifying disposition rules, the adjusted cost base of a Resident Holder's REIT Units (as increased in connection with the Finance Trust Disposition) will be decreased by the REIT Transfer Percentage (being the percentage reduction in the fair market value of a REIT Unit as a result of the REIT Disposition), and the adjusted cost base of a Resident Holder's F17 Trust Units will be increased by the same amount (except to the extent that the Resident Holder's loss, if any, from a disposition of the REIT Units immediately before the REIT Disposition would have been denied under the "dividend stop-loss rules" – which are not expected to have a material impact). Shortly after completion of the Arrangement, the REIT website will post the REIT's estimate of the REIT Transfer Percentage. As a result of the REIT Disposition the REIT will be deemed to dispose of the Amended U.S. Holdco Notes for proceeds of disposition equal to the adjusted cost base of such notes to the REIT immediately before the REIT Disposition.

Withholding tax

Part XIII.2 tax will apply to the amount by which the payment made by the REIT to a Non-Resident Dissenting Holder for fair value of the REIT Unit exceeds the aggregate of the Non-Resident Dissenting Holder's share of the (i) income and (ii) capital gains which are subject to Canadian withholding tax under Part XIII of the Tax Act.

Addition and exercise of Exchange Right

The REIT will not realize any taxable income or gain, either directly or indirectly through Holdings LP and U.S. Portfolio LP, solely by virtue of the amendment of the terms and conditions of the Existing Loans to add the Exchange Right, or the conversion of the Transferred Portion of the Existing Loans into additional common shares of U.S. Holdco pursuant to the Exchange Right.

Portfolio LP Distribution and Portfolio LP Trust Distribution

In 2 and 3, Portfolio LP will distribute its U.S. Holdco Notes to Portfolio LP Trust as a return of capital (the “Portfolio LP Distribution”), and Portfolio LP Trust will distribute the notes to the REIT as a return of capital (the "Portfolio LP Trust Distribution.") On the Portfolio LP Distribution, Portfolio LP will be considered to have disposed of the notes for proceeds of disposition equalling their fair market value, so that it will realize a capital gain (or a capital loss) to the extent that such proceeds of disposition exceed (or are less than) the adjusted cost base of such U.S. Holdco Notes to Portfolio LP immediately before the distribution. The REIT has advised counsel that Portfolio LP, Portfolio LP Trust, and the REIT will make appropriate allocations, distributions and designations such that one-half of the portion of any such capital gain realized by Portfolio LP on the Portfolio LP Distribution that is allocated to Portfolio LP Trust will effectively be treated as a taxable capital gain realized by Unitholders. On the Portfolio LP Trust Distribution, the REIT will be considered to acquire the PHP U.S. Holdco Notes at a cost equal to their fair market value.

Finance Trust Disposition

As a result of the Finance Trust Disposition, Finance Trust will, in accordance with the rules applicable to qualifying dispositions, be deemed to have disposed of its U.S. Holdco Notes for proceeds of disposition equal to its adjusted cost base of such notes. The U.S. Holdco Notes received by the REIT from Finance Trust will be acquired at a deemed cost equal to their adjusted cost base to Finance Trust.

Repaid Portion of the Existing Loans

The Repaid Portion of the Existing Loans will be repaid by U.S. Holdco by the delivery of the Repayment Amended U.S. Holdco Notes, which will have an aggregate principal amount equal to the aggregate principal amount of the Repaid Portion of the Existing Loans. Although it is expected by the REIT that the fair market value of the Repayment Amended U.S. Holdco Notes will be equal to the principal amount of the Repaid Portion of the Existing Loans, the proceeds of disposition of the Repaid Portion of the Existing Loans may nonetheless be greater or less than the adjusted cost base of such loans to the REIT as a result of fluctuations in the Canadian dollar-US dollar exchange rate.

U.S. tax consequences

REIT Disposition

The REIT Disposition in 18 entails the transfer of Amended U.S. Holdco Notes that exceed the principal amount of U.S. Holdco Notes held by Finance Trust (the "Excess Notes"), being up to approximately US$800 million in the aggregate and to be disclosed by the REIT in a press release at or about that time), will be treated as a distribution of such Excess Notes by the REIT to U.S. Holders of Stapled Units. Subject to the PFIC rules: (a) such distribution paid to a U.S. Holder generally will be treated as dividend income to such U.S. Holder to the extent paid out of current or accumulated earnings and profits (as determined under U.S. principles) of the REIT; and (b) to the extent this distribution exceeds earnings and profits, it will be treated first as a return of capital to the extent of the adjusted basis in REIT Units, and then as gain from the sale of a capital asset. While the REIT has historically made annual distributions exceeding its profits (as determined under Canadian tax principles), the REIT does not calculate its earnings and profits under U.S. federal income tax principles and, as a result, this distribution may be treated as a dividend.

Fixed investment trust status

Finance Trust is treated as, and F17 Trust is intended to qualify as, an investment trust that is classified as a grantor trust for U.S. federal income tax purposes under U.S. Treasury regulation section 301.7701-4(c) (a "Fixed Investment Trust") and s. 671 of the Code. In general, an investment trust will qualify as a Fixed Investment Trust if: (i) the trust has a single class of ownership interests, representing undivided beneficial interests in the assets of the trust and (ii) there is no power under the trust agreement to vary the investment of the holders. If Finance Trust and F17 Trust are Fixed Investment Trusts, then they generally will be disregarded for U.S. federal income tax purposes, with the result that the holders of Finance Trust Units or F17 Trust Units will be treated as owning directly their pro rata shares of all of the Finance Trust assets or F17 Trust assets, respectively (i.e., the U.S. Holdco Notes or Amended U.S. Holdco Notes, respectively). Moreover, all payments made on the U.S. Holdco Notes or Amended U.S. Holdco Notes will be treated as payments made directly to the holders of the Finance Trust Units or F17 Trust Units, as applicable, in proportion to their interest in Finance Trust and F17 Trust, respectively.

Treatment of F17 dispositions

Since F17 Trust should qualify as a Fixed Investment Trust, any gain or loss realized by F17 Trust from a sale, exchange, retirement or other disposition of the Amended U.S. Holdco Notes and any gain recognized by holders of F17 Trust Units from a disposition of F17 Trust Units should be treated as having been realized by the holders of the F17 Trust Units directly from a disposition of their undivided interests in the Amended U.S. Holdco Notes.

Portfolio interest exemption

Interest payments on the Amended U.S. Holdco Notes to F17 Trust should qualify as "portfolio interest" under the Code and generally should not be subject to U.S. withholding tax provided that the following requirements are satisfied (under the "Portfolio Interest Exemption"):

• the Non-U.S. Holder does not actually or constructively own 10% or more of the total combined voting power of all classes of U.S. Holdco's stock entitled to vote within the meaning of Section 871(h)(3) of the Code and the regulations thereunder;
• the Non-U.S Holder is not a controlled foreign corporation that is related to U.S. Holdco through stock ownership;
• the Non-U.S. Holder is not a bank whose receipt of interest on the Amended U.S. Holdco Notes is described in Section 881(c)(3)(a) of the Code, and
• the Non-U.S. Holder satisfies the statement requirement set forth in section 871(a) and section 881(c) of the Code and the regulations thereunder, which requirement can generally be met by F17 Trust providing to U.S. Holdco a completed IRS Form W-8IMY.