Crombie REIT -- summary under Internal S. 132.2/107.4 Mergers

Overview

Crombie REIT held the units and notes of a subsidiary unit trust (Crombie Subsidiary Trust), whose principal asset was most of the partnership interests, other than exchangeable LP units held by the Empire group, in a subsidiary LP (“Crombie LP”), which held real estate and a corporate subsidiary (“CDL”).

In a 2017 reorganization, the REIT first eliminated Crombie Subsidiary Trust by setting up a unit trust (“MFT”), having Crombie Subsidiary Trust transfer its assets to MFT under s. 107.4, distributing just enough units of MFT to its unitholders for MFT to qualify as a mutual fund trust, and then instigating a s. 132.2 merger of MFT into the REIT.

The REIT also did not want CDL to be subject to potential corporate income tax. Had the REIT now held CDL directly, this would have been accomplished by incorporating a subsidiary (“MFC”), distributing relatively modest shareholdings in MFC to its unitholders sufficient to qualify MFC as a mutual fund corporation, amalgamating MFC and CDL so that Amalco also qualified as a mutual fund corporation, and then instigating the merger of Amalco into the REIT under s. 132.2 – so that the former assets of CDL were now held directly by the REIT.

A complicating factor was that, as noted, CDL was held by a partnership (Crombie LP). Accordingly, Crombie LP first transferred its CDL shares to MFC under s. 85(2) in consideration for most of the shares of MFC (so that CDL could then be vertically amalgamated with MFC to form Amalco). On the s.132.2 merger of Amalco into the REIT, Crombie LP renounced the receipt of the REIT units that otherwise would be receivable by it on the redemption of its Amalco shares. CRA ruled that Crombie LP was not required to include any amount in its income as a result of the exercise of its right of renunciation.

Current structure

Crombie holds its Class A LP units of Crombie Limited Partnership (“Crombie LP”) through a subsidiary unit trust (Crombie Subsidiary Trust). ECL Developments Limited, an indirect wholly-owned subsidiary of Empire Company Limited (“Empire”), holds Class B exchangeable LP units of Crombie LP. By virtue of holding special voting units of Crombie and Units of Crombie, the Empire group controls 41.15% of the voting rights respecting the outstanding Crombie Units. Crombie LP holds all the shares of CDL.

Purpose

The purpose of the proposed reorganization (the “Reorganization”) is to modify the organizational structure of Crombie to eliminate Crombie Subsidiary Trust and CDL. The elimination of Crombie Subsidiary Trust simplifies the structure and will allow Crombie to hold its investment in Crombie LP directly. Similarly, the elimination of CDL will further simplify the structure and will eliminate potential income tax expense that could be incurred by CDL

Formation of MFT

MFT will be an unincorporated open-ended trust established under the laws of the Province of Ontario pursuant to the MFT Declaration of Trust. The sole trustee of MFT will be an individual resident in Canada. MFT will qualify as a “unit trust” pursuant to the Tax Act on the basis that its units are redeemable on demand by the holder thereof. The units will also be redeemable by MFT.

Formation of MFC

MFC will be a corporation governed by the laws of Canada. The articles of MFC will provide that its only undertaking will be activities described in s. 131(8)(b) of the Tax Act. The authorized share capital of MFC will consist of an unlimited number of common shares, Class A Preferred shares and Class B Preferred shares.

Ruling

Crombie has applied for an advance income tax ruling from CRA in connection with the Reorganization (see 2016-0660321R3). Crombie will not complete the Reorganization without receiving a favourable ruling.

Reorganization steps

1. Opco and a newly-incorporated subsidiary of Opco (GP II) will form a general partnership (the “Partnership”), with Opco transferring real estate to Partnership on a s. 97(2) rollover basis.
2. Partnership will then be converted to a limited partnership, with no significant changes to the rights and obligations of the partners other than Opco becoming a limited partner.
3. After the settling of a new unit trust (“MFT”), having redeemable retractable units, by a Canadian-resident third party, Crombie subscribes for MFT units for nominal cash consideration and the unit of the settlor is redeemed.
4. Crombie Subsidiary Trust will transfer all its assets to MFT for no consideration, and will be terminated.
5. Crombie will distribute a certain number of its MFT Units to Crombie Unitholders, having a nominal value, as a distribution of capital (with s. 218.3(2) withholding being made).
6. The Declaration of Trust of Crombie will be amended to provide for the consolidations in 10 and 20 below, for the in specie redemption of Crombie units through distribution of securities of a Crombie subsidiary including MFT Units and adding the Right of Renunciation utilized in 19 below.
7. Pursuant to a transfer agreement between Crombie, MFT and an agent for the MFT Unitholders, MFT will transfer its assets to Crombie in consideration for Crombie Units.
8. MFT will redeem all of the MFT Units except for one MFT Unit held by Crombie. The redemption price will be satisfied by the transfer by the MFT agent of the Units it holds to the holders of the redeemed Units.
9. Crombie will cancel the Units so received by it.
10. Immediately thereafter the outstanding Crombie Units are consolidated so as to result in the same number as before.
11. A joint s. 132.2 election will be made by Crombie and MFT.
12. Ultimately, MFT will be wound up.
13. Crombie will incorporate MFC, subscribe for five MFC Common Shares and 95 (non-voting redeemable retractable) MFC Class A Shares for $0.01 per share, list the MFC Class A Shares on the Exchange and subscribe for further MFC Class A Shares such that the total outstanding number of shares will now equal the number of outstanding Crombie Units.
14. Crombie LP will transfer all of its shares of Crombie Developments Limited (“CDL”) together with a note owing by CDL (the “Note”) to MFC in consideration for MFC Class B Shares (having similar attributes to the MFC Class A Shares), with the s. 85(2) election to be filed by Amalco and Partnership.
15. Crombie will distribute to Crombie Unitholders, as a return of capital, all of its MFC Class A Shares and, in due course, remit any applicable s. 218.3(2) withholding tax.
16. MFC and CDL will amalgamate, with the CDL Shares and Note being cancelled on the amalgamation and the outstanding shares of MFC being converted on the amalgamation into the equivalent number of Amalco Class A, Class B and Common Shares.
17. Amalco will transfer all of its assets to Crombie in consideration for the assumption of its liabilities and Crombie’s agreement to issue Crombie Units to the agent for the holders of the Amalco Class A and B Shares in satisfaction of the redemption price for their shares (see 17 below).
18. Immediately after the transfer in 17, Amalco will redeem the Amalco Class A and B Shares and thereupon the agent for the holders of the Class A Shares will transfer a portion of the Units its holds to the holders of the Amalco Class A Shares.
19. Crombie LP will renounce all of its interest in Crombie, so that rather than receiving Crombie Units, they will be cancelled.
20. The outstanding Crombie Units will be consolidated, so that the number outstanding will be the same as before the reorganization.
21. A joint s. 132.2 election will be made by Crombie and Amalco.
22. Crombie will contribute its Partnership Units and its shares of GP II and Amalco to Crombie LP, with a joint s. 97(2) election being filed.
23. Partnership will be wound-up under s. 98(3).
24. GP II will sell its undivided interest in each property received by it in 23 to Crombie LP for fair market value consideration and then will be wound up.

Canadian tax consequences

Transfer of Property to the Partnership

Provided that the necessary election is filed, the transfer by CDL of its properties to the Partnership will occur on a tax-deferred basis.

Transfer by Crombie Subsidiary Trust to MFT

Provided that the necessary election is filed, the transfer of assets by Crombie Subsidiary Trust to MFT will be characterized as a “qualifying disposition” for purposes of section 107.4 of the Tax Act such that the assets will be transferred to MFT for proceeds of disposition equal to the tax cost of such assets. In such circumstances, there should be no taxable income or gain to Crombie Subsidiary Trust arising from such transfer.

Transfer by MFT to Crombie

Provided that the necessary election is filed, the transfer or assets by MFT to Crombie and the redemption by MFT of the MFT Units as described in 8 above will constitute a “qualifying exchange” as defined in section 132.2 of the Tax Act, thereby allowing each of the assets of MFT to be transferred to Crombie on a tax-deferred basis. In addition, MFT will not realize a gain or loss on the transfer of the Units to its Unitholders on the redemption of MFT Units. As a consequence of these transactions, among other things: each of Crombie and MFT will have a deemed taxation year end; unrealized losses in property of Crombie will be deemed to have been realized prior to such deemed year end, and unrealized gains may be treated as having been realized if Crombie elects to file the appropriate designation with CRA; loss carryforwards of Crombie in respect of taxation years beginning before the qualifying exchange may not be deducted in computing taxable income for a subsequent taxation year,…

Acquisition and Distribution of Preferred Shares of MFC

Crombie will subscribe for Class A Preferred shares of MFC for nominal cash consideration. Upon distribution of Class A Preferred shares to Unitholders, Crombie will be considered to have disposed of such Class A Preferred shares for proceeds of disposition equal to the fair market value of such Class A Preferred shares.

Transfer by Crombie LP to MFC

Provided that the necessary election is filed, no taxable income should be realized as a result of the transfer by Crombie LP of its common shares of CDL, and the Note, to MFC.

Amalgamation of MFC and CCL

No taxable income will be realized by Crombie, MFC or CDL because of the amalgamation of MFC and CDL to form Amalco.

Transfer by Amalco to Crombie

Provided that the necessary election is filed, the transfer of Amalco’s assets to Crombie, Crombie’s issuance of Units, the redemption of shares by Amalco and the renunciation by Crombie LP of its interest in Crombie, as contemplated in 17 to 19 above, will constitute a “qualifying exchange” as defined in s. 132.2, thereby allowing the assets of Amalco to be transferred to Crombie for proceeds of disposition equal to the tax cost of such assets. In such circumstances, there should be no taxable income to Amalco arising from such transfer. In addition, Amalco will not realize a gain or loss on the transfer of the Units to its shareholders on the redemption of its Class A Preferred shares. Crombie LP will not be required to include any amount in its income as a result of the exercise of its right of renunciation. As a consequence of these transactions, among other things: each of Crombie and Amalco will have a deemed taxation year end; unrealized losses in property of Crombie will be deemed to have been realized prior to such deemed year end, and unrealized gains may be treated as having been realized if Crombie elects to file the appropriate designation with CRA; loss carryforwards of Crombie and Amalco in respect of taxation years beginning before the qualifying exchange may not be deducted in computing taxable income for a subsequent taxation year.

Return of Capital on the Distribution of MFT Units

A Unitholder will not be required to include in computing income for the year the value of the MFT Units received from Crombie as a return of capital on its Units in Step 8. A Unitholder will be required to reduce the adjusted cost base of its Units by the fair market value of the MFT Units received by that Unitholder.

Disposition of MFT Units in Exchange for Units

A Unitholder holding MFT Units will not realize a capital gain or capital loss as a result of the receipt of Units on the redemption of MFT Units in Step 8.

Consolidation of Units

The consolidation of the Units in Steps 10 and 20 will not be considered to result in a disposition of Units.

Return of Capital on the Distribution of MFC Shares

A Unitholder will not be required to include in computing income for the year the value of Class A Preferred shares of MFC received from Crombie as a return of capital on its Units in Step; 15. A Unitholder will be required to reduce the adjusted cost base of its Units by the fair market value of the Class A Preferred shares received by that Unitholder.

Disposition of Class A Preferred shares in exchange for Units

A Unitholder holding Class A Preferred shares will not realize a capital gain or capital loss as a result of the receipt of Units on the redemption of Class A Preferred shares in Step 18.

Part XIII.2 tax

Since a Non-Resident Unitholder will generally not be subject to Canadian income tax under Part I of the Tax Act or Canadian withholding taxes under Part XIII of the Tax Act on the nominal value of the MFT Units distributed as a return of capital on Crombie Units, such Non-Resident Unitholder will generally be subject to Part XIII.2 withholding tax on such distribution. Crombie will remit, on behalf of the Non-Resident Unitholders, the amount of such tax – and similarly respecting the nominal value of the Class A Preferred shares distributed as a return of capital on Crombie Units.