Potential for deemed loan JV provisions to constitute borrowing ((p. 29-4)
Many joint venture agreements contain a clause providing that if one of the parties (“the defaulting party”) to the agreement defaults on certain financial obligations, the other party (“the non-defaulting party”) may satisfy such a financial obligation on the defaulting party’s behalf. …
If the pension plan is subject to one of these deemed loans, then—notwithstanding the fact that the pension plan has not actually been advanced any funds—the deemed loan could still be viewed as a borrowing for the purposes of regulation 8502(i). …
Hotel or ALF income not from property (p. 29-5)
[I]t must be ensured that any borrowing by a joint venture that includes a pension plan is used to acquire real property that produces rental income, not real property that produces income from the provision of services or income from a business, such as a hotel or an assisted-living centre.
Allocated LP income is income derived from an investment (pp. 29:7-9)
[T]he technical notes to section 253.1 implicitly contemplate that a partnership interest would be an “investment” for the purposes of paragraph 149(1)(o.2), and it would be illogical to consider that this conclusion is not valid with respect, specifically, to the investment tests in subparagraph 149(1)(o.2)(iii). …
[A]nalysis of the meaning of the word “derive” also demonstrates that when an investment corporation acquires an interest in a limited partnership that allocates partnership income or gains to the investment corporation, the income allocated to the investment corporation is derived from that limited partnership interest. …
It is clear that the income allocated to an investment corporation by a limited partnership arises (in other words, has its origin or source) only as a result of the investment corporation’s investment in the limited partnership. Therefore, even if the income allocated to the investment corporation is, in some sense, not from its interest in the limited partnership but from the underlying investments of the limited partnership, it is only as a result of the investment corporation’s direct investment in the limited partnership that any such income will arise. Thus, for the purposes of clause 149(1)(o.2)(iii)(C), the investment corporation’s allocations of the limited partnership’s income or gains must be derived from such investment.
The CRA has implicitly accepted that, if section 253.1 is applicable (as would be the case in figure 2), a limited partner’s allocable share of income of a limited partnership is income derived from an “investment,” regardless of the character or source of the income in the hands of the limited partnership. For example …2000-0055463… .
Trade payables not bonds etc. (p. 29:10)
[T]he CRA has accepted that intercompany payables and trade payables that are not evidenced in writing are not considered to be bonds, notes, debentures, or “similar obligations” for the purposes of clause 149(1)(o.2)(iii)(B). [fn 18: 2012-0461151E5]. … [T]rade payables not evidenced in writing are not similar to bonds, notes, debentures, or mortgages. …
Bonds etc. issued by LP are not issued by (o.2) corp as limited partner (pp. 29:10 -
In some common-law jurisdictions, a debt obligation issued by a partnership might be considered to be a debt obligation issued by the partnership’s investors….
Hudson’s Bay Company v. OMERS … denies the existence of any legal relationship between the limited partners and a third party that has entered into a contract with the limited partnership (or, as the court more precisely puts it, a contract between the third party and the general partner acting in its capacity as general partner of the limited partnership). …
[S]ection 253.1 provides that, for the purposes of paragraph 149(1)(o.2) and other listed provisions, when a trust or a corporation holds an interest as a member of a partnership and, by operation of law, the liability of the partner as a member of the partnership is limited, the partner is not considered to be carrying on the business or other activity of the partnership solely by virtue of acquiring or holding an interest in the partnership. … The issuing of debt should be viewed as part of the “business” or “activity” of the partnership that would not, as a result of section 253.1, be considered to be carried on by the investment corporation. …
Consolidated Mogul … [stated:]
[T]he financing function of a mining company is an integral part of its business.
… Accordingly … [t]he result of such application is that the issuance of a debt obligation by a limited partnership should not be attributed to its limited partners.
Guarantee of LP debt does not engage s. 149(1)(o.2)(iii)(B) (pp. 29:13 - 16)
[O]n June 26, 2013…the phrase “that had not issued debt obligations” was replaced with “that had not . . . issued bonds, notes, debentures or similar obligations.”…
[A]ccording to … Federated Co-operatives … “similar obligation” is a narrower category than “obligation.” It includes only obligations that have a character similar to bonds, notes, debentures, and mortgages—namely, the character of debt. As noted by the court, each of bonds, notes, debentures, and mortgages “is a document evidencing indebtedness of the maker in the form of a promise to pay” and indebtedness for which the issuer is primarily (not secondarily) liable. … In this respect, a guarantee would likely not be considered to be a “similar obligation”… .
… Generally, if the guarantee is a performance guarantee, the investment corporation has no obligation to pay a sum certain or readily reducible to certainty. Thus, while the performance guarantee may create a liability for the investment corporation in the sense of unliquidated or unspecified legal obligations, it should not result in the creation of a debt obligation in the sense of an obligation to pay liquidated or certain sums. …
… With respect to the investment corporation guaranteeing the debt obligations of the limited partnership,…Arguably, however, such a guarantee should not be considered to be a bond, note, or debenture for the purposes of clause 149(1)(o.2)(iii)(B), because no creditor-debtor relationship is created under which the investment corporation is primarily liable for the particular debt. In other words, as the Federal Court of Appeal stated in Federal Co-operatives, such a guarantee would be “merely a secondary obligation that is contingent upon the [limited partnership’s] failure to pay.”
No incurring of debts of subsidiary unit trust (p. 29:17)
… Consistent with the general scheme for the taxation of trusts and their beneficiaries, a CRA technical interpretation states that when an investment corporation is a beneficiary of a trust, the investment corporation is not considered to be the issuer of debt obligations issued by the trust. [fn 47: 2006-0195451R3]…
Issues where co-investing in real estate (pp. 29:18-19)
[A] pension plan may want to co-invest…[and] might establish a real estate corporation… .
… If the real estate corporation performs any activities in relation to the real estate property, a concern may arise as to whether the real estate corporation has satisfied the requirement of subclause 149(1)(o.2)(ii)(A)(I), given that it would be performing activities on a real estate property part of which is not owned by the corporation, by another real estate corporation, or by a registered pension plan.
… [Subsequently to … 9401608, CRA] stated that it had re-examined its position and was now of the view that a co-ownership situation would not jeopardize a real estate corporation’s tax status. Further, the CRA provided that the activities carried on by the real estate corporation in relation to the co-owned property should be proportionate to the interests held by “qualified” entities under subclause 149(1)(o.2)(ii)(A)(I) (that is, by the real estate corporation, by another real estate corporation, or by a registered pension plan) … .
… Pension plans looking to co-invest in real estate property may want to avoid these issues by using a structure….[in which] the real estate corporation would hold a co-ownership interest in the real estate property with the third-party taxable corporation. The parties would then lease the real estate property to a leasing corporation, which would be responsible for leasing the property to various tenants.
Limitations on borrowing (pp. 29:20-21)
[B]orrowing to fund a tenant inducement payment… should generally satisfy the borrowing restrictions, since the purpose of the borrowing is to earn rental income from the real property being leased. However, borrowing to lend money to a tenant to fund tenant improvements is not permitted, since any income earned from the loaned money will be interest income earned on the loan, not income earned from real property. In these cases, in order to comply with clause 149(1)(o.2)(ii)(C), the real estate corporation can borrow money and fund the tenant improvements itself. The lease can be amended to increase the rent in order to compensate the landlord… .
Further, a real estate corporation is not permitted to borrow funds to pay dividends or return capital to its shareholders, even if the borrowed money is being used to replace capital that was contributed by the shareholders and to earn income from real property. [fn 51: 2002-0134885] One option for addressing this issue is to internally finance the real estate corporation with one or more loans. The real estate corporation can use this borrowed money for the purpose of earning income from real property. One option for addressing this issue is to internally finance the real estate corporation with one or more loans. The real estate corporation can use this borrowed money for the purpose of earning income from real property. … At a subsequent date, the internal financing can be refinanced by having the real estate corporation borrow from an arm’s-length lender and repay the internal financing. When new borrowing is used to repay old borrowing that was originally used for a “good” purpose, the new borrowing will also qualify as a “good” borrowing… .
10% rule (pp. 29:26-28)
“[T]he 10 percent rule” … is found in section 9 of the PBSA investment rules, and it requires the diversification of plan assets in the following terms:
9(1) The administrator of a plan shall not, directly or indirectly, lend or
invest moneys of the plan to or in any one person, any associated persons
or any affiliated corporations if(a) 10% or more of the total market value of the plan’s assets has
already been lent or invested, in total, to or in the person, the associated
persons or the affiliated corporations; or(b) 10% or more of the total market value of the plan’s assets would
be lent or invested, in total, to or in the person, the associated persons or
the affiliated corporations as a result of the loan or investment.Although the terms in which the court [in … R v. Christophe, 2009 ONCJ 586] describes the intent of the 10 percent rule are broad, the court essentially echoes the statement of legislative intent by finding the purpose of the rule to be the diversification of investments and loans, such that risk is not pooled in any one person.
… In September 2000, OSFI sent a memo to all members of the Canadian Association of Pension Supervisory Authorities (which included the CRA) stating that OSFI would adopt an interpretation according to which the 10 percent rule needed to be satisfied at the plan level rather than at the level of the individual investment corporation. A similar ruling was given in…2005-0126841R3…
When it comes to interpreting two statutes with overlapping subject matter, a common-law presumption exists that the statutes should be interpreted in a coherent and consistent manner. …
[T]he CRA … confirmed that the 10 percent rule for the purposes of the preamble in subparagraph 149(1)(o.2)(iii) was to be applied at the plan level and not at the corporation level. [fn 76: 2013-050832117]
30% rule (pp. 29:28-29)
“[T] he 30 percent rule”) is found in section 11 of the PBSA investment rules, and it provides…
11(1) Subject to subsection (2), the administrator of a plan shall not, directly or indirectly, invest the moneys of the plan in the securities of a corporation to which are attached more than 30 per cent of the votes that may be cast to elect the directors of the corporation.
(2) Subsection (1) does not apply in respect of investments in securities of
(a) a real estate corporation;
(b) a resource corporation; or
(c) an investment corporation.
… [T]he 30 percent rule applies only to securities to which more than 30 percent of the voting rights to elect directors are attached … . [I]t does not prevent a pension plan from holding shares that vote on issues other than the election of directors, such as the approval of fundamental matters… .
Consequences of PBSA rules non-compliance (p. 29:29)
Regulation 8501(2)(a) of the Act provides that a plan becomes a revocable plan if it fails to comply with a number of provisions within the regulations, including regulation 8502(h), which provides that the property of the pension plan must not include, among other things, an investment that is not permitted under the PBSA or a similar law of a province.
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