Commercial Property- Canada

Canadian pension funds and their subsidiary pension realty corporations are frequently subject to limitations on the nature of the activities and investments that they are permitted to undertake. In particular, development projects can give rise to issues regarding a pension fund's ability to participate in such investments.

When Canadian pension funds acquire real estate, they usually do so through subsidiary corporations described in Paragraph 149(1)(o.2) of the Income Tax Act. These pension realty corporations offer their shareholder pension funds the protection of limited liability, which is an important consideration in the case of large or risky real estate projects. Provided that such corporations are owned and limit their activities and investments in compliance with Paragraph 149(1)(o.2) of the act, the corporations will be exempt from tax under Part I of the act in the same manner as their pension fund shareholders.

Types of Pension Realty Corporation

Pension realty corporations fall into two categories. Corporations described in Paragraph 149(1)(o.2)(i) of the Income Tax Act must have been incorporated before November 17 1978 solely in connection with, or for the administration of, a registered pension plan. The act requires that the shares of these pre-November 1978 corporations be owned by one or more pension funds or similar entities, but otherwise imposes no restrictions on the activities or investments capable of being pursued by such corporations. The other, far more common type of pension realty corporation is described in Paragraph 149(1)(o.2)(ii) of the act. In addition to being owned solely by one or more pension funds or other similar entities, these corporations must limit their activities and investments strictly in accordance with Paragraph 149(1)(o.2)(ii) of the act. Failure to comply with the statutory limitations will result in the corporation losing its tax-exempt status - a highly undesirable result.

Permitted Activities

Development projects pose special challenges for Paragraph 149(1)(o.2)(ii) corporations because the development of real property does not necessarily fall squarely within the permitted activities of "acquiring, holding, maintaining, improving, leasing or managing capital property that is real property" contemplated by the act.

Capital Property

The property in question must be 'capital property'. In general, this means that the property must be acquired with a view to holding it for long-term investment purposes. Certain development projects, such as residential condominiums intended for sale to investors or occupants, do not fall into this category.

Development Activities

The permitted activity of improving real property set out in Paragraph 149(1)(o.2)(ii) of the act seems to encompass most development activities. However, at one time the Canada Revenue Agency thought differently; in 1991 and 1992 it determined in technical interpretations that a passive role was required, which did not permit the development of real property. This position was revised in subsequent technical interpretations so that activities "undertaken to increase the return on investment on capital property" are acceptable. Development activities are permissible provided that they are associated with the earning of passive investment income on capital property, as opposed to development activities undertaken "with the intent to improve and develop for sale at a profit", which are not permitted.

Regulatory Limits

Paragraph 149(1)(o.2)(ii) corporations are also required to make no investments other than in real property or an interest therein, or investments that a pension plan is permitted to make under the Pension Benefits Standards Act 1985 or a similar provincial law. This brings into consideration various qualitative and quantitative limits imposed under pension regulatory legislation. Perhaps the most important of these is that the proposed investment must comply with the written statement of investment policies and procedures of the shareholder pension fund and/or the pension realty corporation. The written statement of investment policies and procedures may restrict development activities in general, and very large or risky development projects in particular.

Other Investment Structures

Pension funds and pension realty corporations may also acquire real estate indirectly in conjunction with other participants through investments in partnerships or limited partnerships. Like corporations, limited partnerships offer limited liability protection, but do not allow limited partners to participate in the management and operation of the real property. Direct investments by pension funds in limited partnerships are subject to the qualitative and quantitative limits imposed by pension regulatory legislation, including the written statement of policies and procedures. Investments by pension realty corporations in limited partnerships are generally characterized as 'investments' (as opposed to 'activities'), provided the pension realty corporation is an inactive limited partner.

Alternatives

If development activities are prohibited by the written statement of policies and procedures of the pension fund or its pension realty corporation, it may nevertheless be possible for the pension realty corporation to participate in the project by obtaining an option to acquire the property or an interest therein once the development is complete. This may be coupled with a financing arrangement, the repayment of which is capable of being offset against the option purchase price. Under this scenario, the mortgage financing arrangements and the option must comply with the qualitative and quantitative limits imposed by pension regulatory legislation, including the written statement of policies and procedures.

International Law Office