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Responding to the "Halloween Surprise": Using Plans of Arrangement to Convert Income Trusts to Corporations

Date

March 26, 2010

AUTHOR(s)

James Farley
Geoff R. Hall
Mason Poplaw
Scott Smythe


On the evening of October 31, 2006, the federal government’s "Halloween surprise" ended the favourable tax treatment formerly afforded to income trusts. The new tax rules come into effect in 2011. As a result, many income trusts are now in the process of converting into corporations ahead of the deadline.

A number of such conversions have been accomplished by means of plans of arrangement under the Canada Business Corporations Act (CBCA) or provincial equivalents. The flexibility of arrangement provisions makes them particularly well-suited for conversions, which are often highly complex transactions.

Yet there had been a lagging doubt about the propriety of this approach: could a corporate statute really be used to effect a fundamental change to a trust?

This doubt has now disappeared. In Re Acadian Timber Income Fund, 2009 CanLII 72057, Justice Sarah Pepall of the Ontario Superior Court of Justice (Commercial List) tackled the question of whether Section 192 of the CBCA (the plan of arrangement provision) can be used to effect an exchange of securities involving an income trust. Her answer was a clear "yes."

Justice Pepall noted that the word "arrangement" in Section 192 is "to be given its widest character, limited only by the corporation’s own bylaws or general legislation" and that "the purpose of an arrangement is to provide a flexible mechanism that can be adapted to the needs of a particular case." She then quoted her former colleague, Justice James Farley (who, of course, has been our colleague at the firm since his retirement from the bench): Justice Farley wrote, in Re Fairmont Hotels & Resorts, 2006 CanLII 57092, that "it is an error to forget that the very flexibility of the arrangement provision was designed to allow the solution of difficult and awkward situations."

Noting that not all of the applicants before her were CBCA corporations, Justice Pepall concluded that the arrangement provisions should be available to all the applicants. "It seems to me that the current income trust conundrum is the sort of exceptional situation contemplated by the dicta in Re Fairmont. Assuming that there is compliance with the provisions of the trust deed (a fact that should be addressed at the approval hearing), there is no apparent prejudice to anyone."

Justice Pepall’s decision is, as she herself noted, consistent with a well-established practice of using arrangement provisions to convert income trusts, with courts in at least four provinces (British Columbia, Alberta, Ontario and Québec) having allowed such arrangements to proceed.

Yet few courts have expressly considered the propriety of the practice in the way Acadian Timber has. It is therefore a welcome judicial seal of approval on the practice.

McCarthy Tétrault Notes

The practice of using plan of arrangement provisions to convert income trusts into corporations — widely followed, but up until now rarely commented on in the case law — has now received full judicial approval. Any lingering doubts about the propriety of the practice have disappeared, with the only limitation being that at least one of the applicants in the proceeding must be a corporation incorporated under the statute in question. Given the flexibility of arrangements, and how well-suited they are for such complex conversions, this is a welcome development.

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