While pension funds have staked a major claim in the Canadian real estate sector, pension realty corporations must be diligent in observing tax laws or risk losing the advantages they enjoy, according to a legal expert.
Speaking at a seminar in Toronto on Wednesday, Chris Huband of Blakes law firm explained that many of the country’s trophy real estate assets are now owned wholly or in part by pension plans, but such organizations must tread carefully in order to maintain a profitable investment.
“Any pension fund that plans to purchase real estate must set up a pension realty corporation, which gives it tax-exempt status,” explained Huband. “The rules are complicated and designed to prevent pension realty corporations from gaining an unfair advantage over regular companies. A single misstep can cause the corporation to become taxable under the income tax act.”
Under the Income Tax Act (ITA), there are two types of pension realty corporations: those registered prior to 1978 and those registered afterwards. The former is very rare and is registered solely in connection with and for the administration of a registered pension plan. Only one rule governs this type of pension realty corporation, according to Huband. Namely, that the shares of the corporation must always have been held by one or more pension funds or related entities.
The most common type by far is the latter, which face restrictions on share ownership, activities they can pursue, investments they can make, and borrowing that they can undertake.
Under the ITA, the property in question must be capital property, not inventory. Huband outlined the distinctions between the two as the intentions of the purchaser, the length of time the property was held, and the business carried on by the purchaser. “Generally speaking, the real property must be held for long-term investment purposes,” he said.
The history of pension realty corporations acting as a developer is a long and complicated one, according to Huband. “At one time there was a great deal of controversy about whether a pension realty corporation was allowed to develop real property, notwithstanding the fact that the word “improving” actually appears on the enumerated list of permitted activities,” he said. The Canada Revenue Agency (CRA) eventually decided to allow pension realty corporations to act as developers provided that the activities were related solely to passive investment income. However, activities for the purposes of resale would not be permitted.
Co-ownership of a property by a pension realty corporations and a taxable entity is a legal gray area, according to Huband. A 1992 decision by the CRA stated such a partnership was not permitted due to a concern that in owning real property in a co-ownership with a taxable entity, the pension realty corporation could use its tax-free status to somehow benefit its taxable co-owner. This was revised in 1994 and declared permissible, but the pension realty corporations could not take on more than their proportionate share of obligations.
Under the CRA, there are significant restrictions on investments for pension realty corporations. They can make no investments other than real estate, or investments that a pension plan is permitted to make under the federal or provincial regulatory statutes. The latter statement is very confusing, explained Huband, as the reference is to a pension plan, rather than the pension plan in question. “It would appear that it’s permissible to make an investment that any pension plan could make under any of the pension regulatory legislation,” he said.
It’s also unclear as to how to apply the second test, according to Huband. Pointing out that the rules are actually written for pension plans as opposed to pension realty corporations, he questioned whether the regulatory rules should be applied to the level of the pension plan, or to the level of the pension realty corporation, applied as if it was a pension plan.
Another source of confusion is the CRA’s distinction between activities and investments. “It would appear that it might be possible for a pension realty corporation to acquire units of a limited partnership as an investment even though the activities carried on by that limited partnership would not be permitted activities for a pension realty corporation,” he said.
The last set of restrictions on investments for pension realty corporations relate to borrowing. Huband explained that the pension realty corporation must borrow money solely for the purpose of earning income from real property or any interest therein. “As such, money cannot be borrowed to fund an investment that is not real property.”
To comment on this story, email jody.white@rci.rogers.com.