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.
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Real estate investment funds have become increasingly popular for those seeking diversified real estate exposure without the complexities of direct ownership. In Ontario, one of the most common and effective structures for setting up a real estate investment fund is through a limited partnership (LP) with a general partner (GP). This structure offers tax efficiency, flexibility, and clear delineation of responsibilities and liabilities for investors.
Understanding the legal, tax, and regulatory framework of limited partnerships is essential for real estate investment funds using this model. This guide covers the fundamentals of structuring a real estate investment fund using a limited partnership in Ontario.
- What is a Limited Partnership (LP)?
A limited partnership is a distinct type of business structure under the Ontario Limited Partnerships Act (LPA) that separates the roles, responsibilities, and liabilities of two types of partners:
General Partner (GP): The general partner is responsible for managing the day-to-day operations of the fund and holds unlimited liability for the fund’s obligations.
Limited Partners (LPs): Limited partners are passive investors who contribute capital to the partnership but do not take part in management. Their liability is limited to the amount they have invested.
Using an LP structure for a real estate investment fund offers several advantages, such as liability protection for investors, flexibility in profit distribution, and tax transparency.
- Why Use a Limited Partnership for a Real Estate Investment Fund?
There are several benefits to using a limited partnership structure for real estate investment funds:
Limited Liability for Investors: Limited partners (investors) have liability protection, meaning they are only responsible for the amount they invested. This appeals to investors looking to reduce personal risk while enjoying the benefits of real estate investment.
Tax Efficiency: LPs are considered “flow-through” entities for tax purposes. Income earned by the fund flows directly to the partners, who report it on their individual tax returns, avoiding double taxation at the entity level.
Attractive for Raising Capital: LPs are structured to facilitate raising capital from passive investors, who are generally interested in participating in the returns without involvement in management decisions.
Clear Roles and Responsibilities: The GP manages the fund’s activities and oversees investment strategies, while LPs provide capital without taking on operational responsibilities.
- Legal and Regulatory Framework for Setting Up a Limited Partnership Fund in Ontario
Setting up a real estate investment fund using a limited partnership in Ontario involves several regulatory steps and legal considerations:
A. Ontario Limited Partnerships Act (LPA)
Under Ontario’s Limited Partnerships Act, LPs must follow specific registration and operational requirements, including:
• Registration of the LP: To form a limited partnership in Ontario, a Declaration of Limited Partnership must be filed with the Ontario Ministry of Public and Business Service Delivery. The declaration includes the name of the partnership, business address, names of the general partners, and the intended business activities.
• Partnership Agreement: A comprehensive partnership agreement is essential for defining the roles, rights, and responsibilities of the GP and LPs. This agreement typically includes details on:
• Capital contributions and ownership interest
• Profit distribution
• Management and decision-making authority of the GP
• Conditions for adding or removing partners
• Exit strategies and dissolution terms
B. Securities Law Compliance
In Ontario, LP interests are considered securities, making the fund subject to Ontario Securities Commission (OSC) regulations. The OSC mandates that real estate investment funds structured as LPs comply with securities legislation to protect investors.
Prospectus Requirement and Exemptions: If the fund raises capital from non-accredited investors, it may be required to file a prospectus with the OSC. However, funds targeting accredited investors or relying on other exemptions (such as the private issuer exemption) may not need a prospectus, simplifying regulatory compliance.
Offering Memorandum: For funds not filing a prospectus, an offering memorandum (OM) may be prepared to disclose investment risks, management details, and fund strategy. The OM ensures transparency and compliance with securities requirements and protects the GP from potential claims by providing full disclosure to investors.
C. Corporate Structure of the General Partner
To limit liability for the individuals managing the fund, the GP is often structured as a corporation. This corporate GP then assumes unlimited liability on behalf of the LP, while the corporation’s directors and officers are shielded by corporate protections.
Directors and Officers: The directors and officers of the corporate GP are responsible for making investment and operational decisions. They are bound by fiduciary duties, including acting in the best interests of the partnership and its investors.
Tax Implications for the GP: As a corporate entity, the GP has its own tax obligations separate from the LP, and any management fees paid by the LP to the GP may be subject to corporate tax. It’s advisable to consult a tax advisor to structure these arrangements efficiently.
- Tax and Financial Reporting Obligations
Although LPs are flow-through entities for tax purposes, both the partnership and the GP have specific reporting obligations:
Tax Reporting: The LP generally must file an annual partnership information return with the Canada Revenue Agency (CRA), detailing income and losses, which are then allocated to the partners according to their interests.
Investor Distributions: Profits generated from the fund’s investments flow through to the limited partners and are taxed at their individual tax rates. Proper tax planning is essential to maximize after-tax returns for investors.
- Key Steps to Setting Up a Real Estate Investment Fund Using a Limited Partnership in Ontario
Draft the Partnership Agreement: A comprehensive partnership agreement should outline all operational, financial, and governance structures of the LP, including capital contribution requirements, profit-sharing mechanisms, and the GP’s management responsibilities.
Form the General Partner Corporation: Establish the corporate entity that will serve as the GP, protecting individual managers from liability.
Register the Limited Partnership: File the Declaration of Limited Partnership with the Ontario Ministry of Public and Business Service Delivery. This officially establishes the LP and allows it to operate in Ontario.
Prepare an Offering Memorandum (if required): If the fund is soliciting capital from investors, prepare an offering memorandum that details the fund’s strategy, structure, and risks. This document is critical for ensuring transparency and regulatory compliance.
Comply with OSC Securities Regulations: Register the securities offering with the OSC or file for prospectus exemptions as applicable. A lawyer can assist in determining the appropriate exemptions for the fund’s target investor base.
Establish Accounting and Reporting Procedures: Set up systems for financial reporting, investor communications, and tax filings to meet CRA and OSC requirements. Regular, clear reporting helps maintain investor confidence and regulatory compliance.
- Ongoing Governance and Compliance
Once the real estate investment fund is established, the GP is responsible for ongoing management and regulatory compliance. Key areas include:
Investment Management: The GP should adhere to the investment strategy outlined in the partnership agreement and ensure that it acts in the best interests of the LPs.
Financial Reporting: The LP must provide regular financial updates to investors, including distributions and performance reports. Proper financial management and transparency are critical for maintaining investor trust.
Compliance with Securities Law: The GP must ensure that the fund remains compliant with all OSC requirements, including any disclosure obligations and securities regulations.
- Conclusion
A limited partnership with a corporate general partner is an ideal structure for Ontario real estate investment funds, offering tax advantages, liability protection, and flexible capital-raising options. However, setting up such a fund requires careful planning and compliance with legal and regulatory standards. Lawyers play an integral role in drafting partnership agreements, registering the LP, and navigating securities regulations, ensuring the fund is well-structured and fully compliant.
By partnering with knowledgeable legal and tax professionals, fund sponsors and investors can set up a robust, legally compliant real estate investment fund that maximizes potential returns while minimizing risk.
Sources:
Ontario Limited Partnerships Act, R.S.O. 1990, c. L.16.
Ontario Securities Commission
Canada Revenue Agency