This resource has been prepared by Nicholas dePencier Wright of Wright Business Law for educational purposes. This information is current as of the date of writing and does not constitute legal advice, which should be obtained prior to relying on anything herein.
Book a telephone consultation here: https://wrightbusinesslaw.cliogrow.com/book
_______________________________________________________________________________________
- Forming a Real Estate Investment Trust (REIT) in Canada
Real Estate Investment Trusts, or REITs, have gained considerable popularity in Canada as a tax-efficient and accessible way to invest in real estate. A REIT allows investors to pool resources to acquire and manage income-generating properties, including commercial, residential, and industrial real estate. For Ontario-based investors and legal professionals, understanding the formation and operation of REITs in Canada is essential for maximizing the benefits and ensuring regulatory compliance.
This article will walk through the basics of setting up a REIT in Ontario, covering essential legal, tax, and regulatory requirements.
- What is a Real Estate Investment Trust (REIT)?
A REIT is a specialized investment vehicle that holds a portfolio of income-producing real estate properties. Under the Income Tax Act (Canada) REITs are structured as flow-through trusts, providing a tax-efficient way to distribute rental income and capital gains to investors. To qualify for tax benefits, a Canadian REIT must meet certain income and asset criteria. REITs are popular with investors seeking regular income through dividends while avoiding the operational demands of direct real estate ownership.
REITs in Canada generally fall into three categories:
Publicly Traded REITs: Listed on stock exchanges like the Toronto Stock Exchange (TSX), these REITs are widely accessible to retail investors.
Private REITs: Not publicly listed, these REITs typically target accredited or institutional investors and may offer higher returns but can come with higher risks and reduced liquidity.
Mutual Fund Trust REITs: These REITs are structured as mutual fund trusts and are subject to specific restrictions and tax rules under the Income Tax Act (Canada).
- Benefits of Forming a REIT
There are several advantages to forming a REIT, including:
Tax Efficiency: Qualifying REITs are not taxed at the entity level, as long as they distribute most of their taxable income to investors.
Income Distribution: REITs generate regular income for investors in the form of dividends, which typically originate from rental income and capital gains.
Liquidity and Accessibility: Publicly traded REITs provide liquidity for investors, making it easier to buy and sell shares without dealing with the complexities of direct real estate ownership.
Diversification: REITs allow investors to diversify their portfolios with real estate exposure, spreading risk across multiple properties and geographic locations.
- Legal and Regulatory Framework for REIT Formation
Setting up a REIT in Ontario involves meeting several requirements set out under the Income Tax Act (Canada), as well as securities and corporate laws. The primary regulatory considerations include:
A. Taxation
Under Section 122.1 of the Income Tax Act (Canada), a REIT can qualify to receive tax-exempt status if it meets the following conditions:
Ownership Structure: The REIT must be structured as a trust, with unitholders (investors) as beneficiaries.
Income Requirements: At least 90% of the REIT’s income must be derived from eligible sources, such as rental income from real property, mortgage interest, and gains from property sales.
Asset Composition: A minimum of 90% of the trust’s assets must consist of real estate properties, cash, or debt securities.
Distribution Requirements: REITs must distribute a significant portion of their taxable income to unitholders (typically 90% or more) to retain flow through tax status.
B. Securities Legislation and Regulatory Compliance
The Ontario Securities Commission (OSC) regulates REITs and ensures that they comply with securities laws if they are publicly traded or raising funds from investors. Key securities-related requirements include:
Prospectus Requirements: For publicly offered REITs, a prospectus must be filed with the OSC, providing full disclosure of the REIT’s structure, management, financials, and associated risks.
Exemptions for Private REITs: Private REITs that target accredited investors may qualify for exemptions from the prospectus requirement. However, they must still comply with registration and disclosure obligations.
Continuous Disclosure: Publicly traded REITs must adhere to continuous disclosure rules, which include regular financial reporting and disclosures of material changes to protect investors.
C. Corporate and Trust Law
Unlike corporations, REITs are generally structured as trusts under a declaration of trust, with a trustee appointed to manage the assets and operations on behalf of unitholders. This legal structure brings with it unique governance and fiduciary responsibilities.
Declaration of Trust: The declaration of trust is a foundational document that outlines the REIT’s objectives, the trustee’s powers and duties, and the rights of unitholders.
Trustee Duties: Trustees of REITs must act in the best interest of unitholders, adhering to fiduciary standards similar to corporate directors.
Unitholder Rights: Unitholders, like shareholders in a corporation, have rights to receive income distributions, vote on significant changes to the REIT, and inspect financial records.
- Key Steps to Forming a REIT in Ontario
Establish the Trust: Set up a trust and draft the declaration of trust, detailing the REIT’s purpose, investment strategy, governance structure, and income distribution policies.
Determine Compliance with the Income Tax Act (Canada): Work with legal and tax professionals to ensure the REIT meets all requirements under the Income Tax Act (Canada), which includes income, asset, and distribution requirements.
Prepare a Prospectus or Offering Memorandum (if required): For publicly traded REITs or those raising funds from non-accredited investors, prepare a prospectus or offering memorandum detailing the REIT’s objectives, structure, and risks, as required by the OSC.
Register with the Ontario Securities Commission: If offering units publicly, register with the OSC to meet securities compliance obligations, including continuous disclosure requirements.
Set Up Compliance and Reporting Procedures: Establish processes for ongoing reporting, income distribution, and regulatory compliance, including trustee oversight, financial disclosures, and periodic unitholder meetings.
Fund and Launch the REIT: Raise capital by issuing units to investors, following either a public offering (for publicly traded REITs) or a private placement (for private REITs). Once capital is raised, acquire income-generating properties to meet the REIT’s investment objectives.
- Ongoing Compliance and Governance
Maintaining a REIT in Ontario requires a commitment to regulatory compliance, transparency, and strong governance. Some ongoing considerations include:
• Income Distribution: REITs must regularly distribute most of their taxable income to unitholders to maintain their tax-efficient status.
• Continuous Disclosure Obligations: Public REITs must adhere to OSC disclosure rules, providing regular financial updates and reporting any material changes.
• Trustee Governance: The appointed trustees are responsible for managing the REIT in unitholders’ best interests, adhering to fiduciary standards.
• Tax Compliance: REITs must continue meeting Income Tax Act (Canada) requirements annually to maintain their status and avoid taxation at the entity level.
- Conclusion
Setting up a Real Estate Investment Trust in Ontario is a complex process that involves tax planning, legal structuring, and compliance with securities regulations. A well-structured REIT can be an effective and tax-efficient way to generate income from real estate investments. Lawyers, accountants, and other financial professionals play an essential role in ensuring that a REIT meets the legal and regulatory requirements, allowing investors to enjoy the benefits of real estate exposure without the direct ownership burdens.
If you’re considering forming a REIT or investing in one, consult with experienced legal professionals to ensure compliance and optimal structure for your real estate investment goals.
Sources:
Canada Revenue Agency
Ontario Securities Commission
Income Tax Act, RSC 1985, c 1 (5th Supp).