2007 Ruling 2007-0226101R3 - conv of MFT from a closed-end to an open-end fund

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1. Is there a disposition for tax purposes due to changes made? 2.Does 104(7.1) apply given that there will be an in specie distribution where a cash distribution cap is reached?

Position: 1. No disposition. 2. 107(4.1) does not apply.

Reasons: 1. While declaration will be amended to include a right of redemption..all other aspects of units will not change. 2. Units are sold on the open market call for redemption exceeding cash ceiling would be rare and purpose test of 104(7.1) is not met.

XXXXXXXXXX 							2007-022610

Attention: XXXXXXXXXX

XXXXXXXXXX , 2007

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX wherein you request an advance income tax ruling in respect of the above-noted taxpayer. We also acknowledge your correspondence of XXXXXXXXXX .

We understand that to the best of your knowledge, and that of the taxpayers involved, none of the matters considered in this ruling request are:

a) in an earlier return of the taxpayers or related persons;
b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayers or related persons;
c) under objection by the taxpayers or related persons;
d) before the courts or if a judgment has been issued, the time limit for appeal to a higher court has not expired; or
e) the subject of a ruling previously issued by this Directorate to the taxpayers or related persons.

The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader. Unless otherwise indicated, all references to monetary amounts are in Canadian dollars and all statute references are to the Income Tax Act (Canada) (R.S.C. 1985, 5th Supplement, c.1, as amended) (the "Act") or to the Income Tax Regulations (the "Regulations").

I. Definitions

In this letter, the following terms have the meanings specified:

"BCA" means the Business Corporations Act (XXXXXXXXXX );

"Class A LP Unit" means the interest of a limited partner in the capital of LP, designated as a Class A unit of LP, with the terms and conditions described in paragraph 20(b) below;

"Class B LP Unit" means the interest of a limited partner in the capital of LP, designated as a Class B unit of LP, with the terms and conditions described in paragraph 20(c) below;

"closed-end unit trust" means a trust that qualifies as a unit trust under paragraph 108(2)(b);

"Declaration of Trust" means the declaration of trust dated XXXXXXXXXX establishing and governing the FUND, as amended and restated;

"deferred income plans" means any of registered retirement savings plans, registered education savings plans, registered retirement income funds or deferred profit sharing plans;

"Draft Amendments" means the legislative proposals included in Bill C-33 as passed by the House of Commons on June 15, 2007;

"FMV" means fair market value;

"FUND" means the XXXXXXXXXX , a closed-end unit trust formed under the laws of the Province of XXXXXXXXXX pursuant to the Declaration of Trust;

"FUND Asset Transfer Agreement" means the agreement of purchase and sale to be entered into by the FUND and LP as described in paragraph 34 below;

"FUND Unit" means a unit of the FUND, other than a Special Voting Unit, as described in paragraph 2 below;

"GP" means a taxable Canadian corporation incorporated under the BCA, that acts as the general partner of LP;

"GP Common Shares" means the commons shares in the capital of GP;

"GP Unit' means the XXXXXXXXXX % interest of the general partner in the capital of LP, designated as a GP unit of LP, with the terms and conditions described in paragraph 20(a) below;

"LP" means a limited partnership formed by GP, as general partner, and the FUND as limited partner under the laws of the Province of XXXXXXXXXX ;

"LP Agreement" means the agreement governing the affairs of LP entered into by the FUND and GP certain terms of which are described in paragraphs 20 and 22 below;

"LP Units" means the Class A LP Units and the Class B LP Units;

"open-end unit trust" means a trust that qualifies as a unit trust under paragraph 108(2)(a);

"Permitted Investments" means any combination of property described in clauses 108(2)(b)(iii)(A) to (G);

"Right of Redemption" means the right of redemption of a Unitholder to redeem FUND Units pursuant to and subject to the provisions of the amendments to be made to the Declaration of Trust of the FUND, as described in paragraphs 27 through 30 below;

"Special Voting Unit" means a voting unit of the FUND, other than a FUND Unit, as described in paragraph 15(ii) below;

"Stock Exchange" means the XXXXXXXXXX ;

"Subsidiary" of the FUND means any entity, corporation, trust, or partnership in which the FUND holds, either directly or indirectly (through one or more Subsidiaries), XXXXXXXXXX % or more of the beneficial interest therein, including, without limitation, in respect of a corporation, XXXXXXXXXX % or more of the shares of each class of the corporation, in respect of a trust, XXXXXXXXXX % or more of the beneficial interest in the trust, and in respect of a partnership, XXXXXXXXXX % or more of the partnership units or interest in the partnership;

"Unitholder" means a holder of a FUND Unit; and

"Vendor" means a taxable Canadian corporation that deals at arm's length with the FUND.

II. Facts

1. The FUND is a closed-end unit trust and a mutual fund trust as defined in paragraph 108(2)(b) and subsection 132(6), respectively, for the detailed reasons set forth in paragraph 14 below, that was established to invest primarily in XXXXXXXXXX . The FUND has a XXXXXXXXXX year end for purposes of the Act.

2. Under the terms of the Declaration of Trust, the FUND may issue an unlimited number of FUND Units of one class. Each FUND Unit represents an equal undivided beneficial interest in the FUND with all outstanding FUND Units. No FUND Unit has any preference or priority over another. No Unitholder has or is deemed to have any right of ownership in the assets of the FUND. Each FUND Unit confers on the holder thereof the right to vote at any meetings of Unitholders and to participate pro rata in any distributions by the FUND and, in the event of termination of the FUND, in the net assets of the FUND remaining after satisfaction of all liabilities.

3. Pursuant to the terms of the Declaration of Trust, the FUND is required to make monthly distributions to Unitholders, computed on an annual basis, of not less than XXXXXXXXXX % of the Distributable Income (as defined in the Declaration of Trust) of the FUND. However, the FUND may distribute less than XXXXXXXXXX % of the Distributable Income of the FUND in respect of any calendar year if the trustees of the FUND determine that it would be in the best interests of the FUND to do so. Distributions may be adjusted for amounts paid in prior periods if the actual Distributable Income of the prior periods is greater or less than the trustees' estimate for the prior periods.

4. FUND Units are widely held by the public, and to the knowledge of the trustees of the FUND, no person beneficially owns, directly or indirectly, or exercises control or direction over, more than 10% of the issued and outstanding FUND Units, except that the accounts managed by XXXXXXXXXX represented, in the aggregate, approximately XXXXXXXXXX % of the issued and outstanding FUND Units as of XXXXXXXXXX on a non-diluted basis. FUND Units are listed and traded on the Stock Exchange under the symbol XXXXXXXXXX , and are qualified investments for deferred income plans under subsection 4900(1) of the Regulations.

5. The FUND was not established and has not been maintained primarily for the benefit of non-residents of Canada. Section XXXXXXXXXX of the Declaration of Trust provides that non-residents of Canada (within the meaning of the Act) may not at any time be the beneficial owners of more than XXXXXXXXXX %, in the aggregate, of the issued and outstanding FUND Units. There were approximately XXXXXXXXXX FUND Units issued and outstanding as of XXXXXXXXXX . It is estimated that less than XXXXXXXXXX % were owned by non-residents of Canada.

6. The FUND is governed by its trustees consisting of XXXXXXXXXX individuals who are resident in Canada. The trustees own the property of the FUND and conduct and manage the affairs of the FUND. Pursuant to the Declaration of Trust, the FUND Unitholders are entitled to vote with respect to the appointment, election or removal of the trustees of the FUND.

7. The principal office of the FUND is located at XXXXXXXXXX , and it deals with the XXXXXXXXXX Tax Services Office and files its returns with the XXXXXXXXXX Tax Centre. The FUND's account number is XXXXXXXXXX .

8. XXXXXXXXXX .

9. XXXXXXXXXX

10. XXXXXXXXXX .

11. XXXXXXXXXX

12. XXXXXXXXXX

13. XXXXXXXXXX .

14. In accordance with paragraph 108(2)(b), subsections 132(6) and 132(7) and the relevant terms of the FUND Declaration of Trust, the FUND qualifies as a "unit trust" and a "mutual fund trust" for the following reasons:

(i) it is an inter vivos trust resident in Canada the interest of each beneficiary under which is described by reference to units;

(ii) it limits its undertaking to the investing of its funds in property (other than real property or an interest in real property), and to acquiring, holding, maintaining, improving, leasing or managing real property or interest in real property that is a capital property of the FUND or a combination of any of the foregoing activities;

(iii) it complies with the prescribed conditions in section 4801 of the Regulations;

(iv) it was not established and has not been maintained primarily for the benefit of non-residents of Canada as explained in paragraph 5 above;

(v) it invests more than 80% of its property in Permitted Investments;

(vi) it earns more than 95% of its income in respect of any year or period as computed without regard to subsections 104(6) and 49(2.1) from Permitted Investments; and

(vii) it does not invest more than 10% of its property in bonds, securities or shares in the capital stock of any one corporation or debtor.

15. In XXXXXXXXXX , the Declaration of Trust was amended to:

(i) authorize the FUND to enter into an exchange agreement with LP that provides for the contribution of FUND Units to LP in contemplation of an exchange of Class B LP Units into FUND Units in accordance with the terms and conditions of the Class B LP Units as described in paragraph 20(c) below; and

(ii) create a class of Special Voting Units that are authorized for issuance. Each Special Voting Unit entitles the holders thereof to one vote on all matters to be voted on at all meetings of the FUND Unitholders, but otherwise has no economic interest in the FUND. In particular, the Special Voting Units do not entitle their holders to any distributions of income or capital of the FUND, whether in the ordinary course as determined by the trustees of the FUND or on a liquidation of the FUND. In addition, the holders of Special Voting Units have no legal or beneficial interest in the assets of the FUND. As a result, these Special Voting Units have nominal FMV.

16. The authorized capital of GP consists of an unlimited number of GP Common Shares all of which are held by the FUND.

17. A majority of the board of directors of GP are resident in Canada and are not trustees of the FUND. The board of directors of GP has the powers and authority to manage the business and affairs of GP and GP has pursuant to the LP Agreement, the powers and authority to administer, control and operate the business for and on behalf of LP. The trustees of the FUND do not have such powers or authority, or will not limit such powers or authority.

18. GP's principal activity consists of acting as general partner of LP, and in that capacity, of managing the business and affairs of LP.

19. LP was formed for the purposes of facilitating future property acquisitions by the FUND by permitting vendors to transfer property to LP on a tax-deferred basis under subsection 97(2) in exchange for Class B LP Units.

20. Under the terms of the LP Agreement, LP is authorized to issue an unlimited number of GP Units, Class A LP Units and Class B LP Units with the following terms and conditions:

a) Each GP Unit entitles the holder thereof to:

(i) one vote on all matters to be voted on at all meetings of the holders of units of LP; and

(ii) a monthly cash distribution from LP equal to XXXXXXXXXX % of the Distributable Income (as defined in the LP Agreement) of LP.

b) Each Class A LP Unit entitles the holder thereof to:

(i) one vote on all matters to be voted on at all meetings of the holders of units of LP;

(ii) to receive a monthly cash distribution from LP equal to the Distributable Income of LP less the distribution entitlements of the holders of Class B LP Units and GP Units; and

(iii) on the dissolution of LP, to receive its pro rata share of the net proceeds therefrom.

c) Each Class B LP Unit entitles the holder thereof to:

(i) be issued a Special Voting Unit of the FUND, which entitles the holder to vote on all matters in respect of which the FUND Unitholders are entitled to vote at all meetings of such Unitholders, without payment of any further consideration;

(ii) exchange a Class B LP Unit on a one-for-one basis for a FUND Unit, subject to customary adjustments in the event of a reorganization of the FUND Units, rights offerings or special distributions by the FUND, without payment of any further consideration. The exchange right is deemed to have been exercised by the holder immediately before such time as the holder thereof becomes a non-resident of Canada for purposes of the Act;

(iii) receive monthly cash distributions from LP equal, on a per unit basis, to monthly distributions made by the FUND to its Unitholders; and

(iv) on the dissolution of LP, to receive its pro rata share of the net proceeds therefrom.

21. GP subscribed for one GP Unit for a nominal cash consideration of $XXXXXXXXXX , representing a XXXXXXXXXX % general partnership interest in LP, and the FUND subscribed for XXXXXXXXXX Class A LP Units for a cash consideration of $XXXXXXXXXX , representing a XXXXXXXXXX % limited partnership interest in LP, on formation of LP. The Class A LP Units are held as capital property by the FUND.

22. The provisions of the LP Agreement provide, among other things, that:

(i) Class A LP Units may only be issued to the FUND and Class B LP Units may only be issued to a person, other than the FUND, who transfers property to LP on a tax-deferred basis under subsection 97(2);

(ii) all partners of LP must at all times be resident in Canada;

(iii) XXXXXXXXXX % of the income (or loss) of LP with respect to each fiscal year will be allocated to GP at the end of such fiscal year; and

(iv) XXXXXXXXXX % of the income of LP with respect to each fiscal year will be allocated to the limited partners of LP at the end of such fiscal year of LP in the same proportion as the Distributable Income that is paid, payable or allocated to such limited partners. If there is no Distributable Income paid, payable or allocated to the limited partners with respect to a particular fiscal year, the income of LP will be allocated pro rata based on the number of units held by such limited partners. Any loss of LP will also be allocated pro rata based on the number of units held by such limited partners.

23. LP is a "Canadian Partnership" for purposes of the Act, and will continue to be a "Canadian Partnership" at all times throughout the proposed transactions.

24. In XXXXXXXXXX , GP, on behalf of LP, completed an agreement of purchase and sale with the Vendor, pursuant to which the Vendor agreed to sell and LP agreed to purchase certain XXXXXXXXXX property in exchange for cash consideration, the assumption of certain liabilities of the Vendor, and the issuance of Class B LP Units.

25. The Vendor, in its capacity as transferor, and the FUND and GP, as partners of the transferee, will jointly elect under subsection 97(2), in prescribed form within the prescribed time under 96(4) or 96(5), with respect to the transfer described in paragraph 24 above. The elected amounts for purposes of the election will be within the limits prescribed by paragraph 97(2)(a), which provides that the provisions of paragraphs 85(1)(a) to (f) are applicable as modified by paragraph 97(2)(a). The partners of LP may also file elections under subsection 20(24) and section 22 as considered appropriate by the parties.

III. Proposed Transactions

26. The Declaration of Trust of the FUND will be amended to include a Right of Redemption for the FUND units, as described in paragraphs 27 through 30 below, to allow the FUND to qualify as an open-end unit trust rather than a closed-end unit trust. The distribution rights, the voting rights and all other rights attached to the FUND Units will not change.

27. The FUND Unitholders will be granted the right to require the FUND to redeem their FUND Units, at any time on demand, at a price per unit (hereinafter referred to as the "Redemption Price") equal to the lesser of:

(i) XXXXXXXXXX % of the "market price" (as defined in the amended Declaration of Trust) of the FUND Units on the principal market on which the FUND Units are quoted for trading during the 10 trading day period ending on the date on which the FUND Units were surrendered to the FUND for redemption; and

(ii) the "closing market price" (as defined in the amended Declaration of Trust) of the FUND Units on the principal market on which the FUND Units are quoted for trading on the date on which the FUND Units were surrendered to the FUND for redemption.

28. The Redemption Price payable in respect of FUND Units tendered for redemption during any calendar month shall be satisfied by way of a cash payment on the last day of the calendar month following the month in which the FUND Units were tendered for redemption, except that the entitlement of Unitholders to receive such cash payment shall not be applicable if:

(i) the total amount payable by the FUND in respect of all FUND Units tendered in the same calendar month exceeds $XXXXXXXXXX , provided that the trustees of the FUND may, in their sole discretion, waive such limitation in respect of all FUND Units tendered for redemption in any particular calendar month;

(ii) at the time the FUND Units are tendered for redemption, the outstanding FUND Units are not listed for trading on a stock exchange or traded or quoted on any other market which the trustees of the FUND consider, in their sole discretion, provides representative fair market value prices for the FUND Units; or

(iii) the normal trading of the outstanding FUND Units is suspended or halted on any stock exchange on which the FUND Units are listed for trading or, if not so listed, on any market on which the FUND Units are quoted for trading, on the date that such FUND Units are tendered to the FUND for redemption or for more than five trading days during the 10 trading day period commencing immediately after the date on which such FUND Units are tendered for redemption.

29. If a FUND Unitholder is not entitled to receive cash on the redemption of FUND Units as a result of the limitations described in paragraph 28 above, the Redemption Price specified in paragraph 27 above to which the FUND Unitholder would otherwise be entitled shall, subject to receipt of all necessary regulatory approvals, be paid and satisfied by way of a distribution in specie by the FUND of securities of the FUND or a Subsidiary of the FUND, as determined by the trustees of the FUND in their sole discretion.

30. If the FUND makes a distribution in specie as described in paragraph 29 above, it will be authorized to make any capital gain realized by the FUND on the disposition of securities of a Subsidiary of the FUND payable to the Unitholder and will reduce the amount payable to such Unitholder in respect of the redemption of the FUND Units by the amount so allocated to that Unitholder.

31. The Declaration of Trust will also be amended to modify the existing provisions that restrict the investments that may be made by the FUND in accordance with paragraph 108(2)(b).

32. It is anticipated that the Right of Redemption described in paragraphs 27 through 30 above will not be the primary mechanism for FUND Unitholders to dispose of their FUND Units.

33. No FUND Units will be cancelled or redeemed and the existing FUND Unitholders will not receive, and shall not be entitled to receive, any proceeds of disposition in respect of the amendments to the Declaration of Trust of the FUND as described in paragraphs 27 through 31 above.

34. The FUND and LP will enter into the FUND Asset Transfer Agreement pursuant to which the FUND will transfer the assets specified under this agreement to LP for a purchase price equal to the aggregate FMV of the assets so transferred. LP will satisfy the purchase price by (i) assuming any outstanding liabilities and obligations of the FUND that do not exceed in the aggregate the cost amount of the assets so transferred, and (ii) issuing Class A LP Units with a FMV equal to the aggregate FMV of the assets so transferred over the principal amount of the assumed liabilities and obligations of the FUND.

35. The FUND, in its capacity as transferor, and the FUND, the Vendor and GP, as partners of the transferee, will jointly elect under subsection 97(2), in prescribed form and within the prescribed time under subsection 96(4) or 96(5), with respect to the transfer described in paragraph 34 above. The elected amount for purposes of the election will be within the limits prescribed by paragraph 97(2)(a), which provides that the provisions of paragraphs 85(1)(a) to (f) are applicable as modified by paragraph 97(2)(a). The partners of LP may also file elections under subsection 20(24) and section 22 as considered appropriate by the parties at the time of the transfer described in paragraph 34 above.

36. Concurrently with the transaction described in paragraph 34 above, the FUND will subscribe for additional units of GP for a cash contribution. GP will use these funds to subscribe for additional GP Units of LP in order to maintain the partnership interest of GP in LP at XXXXXXXXXX %.

37. The FUND Unitholders approved the proposed transactions described herein by way of special resolution at a meeting of FUND Unitholders held on XXXXXXXXXX

IV. Purpose of the Proposed Transactions

38. The purpose of the proposed transactions described in Section III above is to maximize Unitholder value and to increase the value of the FUND's XXXXXXXXXX properties, by providing a more flexible legal and operating structure. An open-end unit trust is a more preferable vehicle than the closed-end unit trust because an open-end unit trust is not subject to many of the restrictions and limitations imposed on closed-end unit trusts. The LP will also facilitate future property acquisitions by the FUND by providing potential vendors with the ability to transfer their property to LP on a tax deferred basis under subsection 97(2).

39. The addition of the Right of Redemption will also provide Unitholders with an additional means of realizing on their investment in the FUND. While it is expected that the investors' primary source of liquidity for FUND Units will continue to be through their sale on the Stock Exchange, under certain circumstances, redemption may be a preferred alternative to public trading. For example, at times when FUND Units are thinly traded, a redemption might be the preferred mechanism for Unitholders to realize on the true FMV of their investment in the FUND.

40. The purpose of allocating capital gains to unitholders on an in specie distribution is to introduce a new method of allocating capital gains to unitholders which will provide unitholders with a more equitable allocation of capital gains.

V. Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purposes of the above transactions, and provided that the proposed transactions are completed in the manner described above, and there are no other transactions which may be relevant to the rulings requested, our rulings are as follows:

A. The variation of the Declaration of Trust of the FUND in order to provide for the Right of Redemption will not, in and by itself, result in a disposition by the existing FUND Unitholders of any portion of their FUND Units.

B. The variation of the Declaration of Trust of the FUND described in paragraphs 27 through 31 above will not, in and by itself, result in a disposition by the FUND of its property or in a resettlement of the FUND.

C. The FUND will qualify as an open-end unit trust pursuant to paragraph 108(2)(a) at the time immediately after the variation of the Declaration of Trust of the FUND providing for the Right of Redemption.

D. The proposed transactions described in paragraphs 27 through 31 above will not, in and by themselves, adversely affect the qualification of the FUND as a mutual fund trust within the meaning of subsection 132(6).

E. Provided that a joint election under subsection 97(2) is filed in prescribed form within the prescribed time in subsection 96(4) or 96(5) in respect of the transfer of the assets of the FUND under the FUND Asset Transfer Agreement described in paragraph 34 above, in the manner and as described in paragraph 35 above, the rules in subsection 97(2) will apply to this transfer.

F. Section 253.1 will apply in respect of the proposed transactions such that the FUND shall not be considered to be carrying on any business or other activity of LP, for purposes of paragraph 132(6)(b), solely because of its acquisition and holding of its interest in LP.

G. The implementation of the proposed transactions described herein, and in particular, the right to make any capital gains realized by the FUND on the disposition of securities of a Subsidiary of the FUND payable to Unitholders as described in paragraph 30 above, will not, in and by themselves, cause subsection 104(7.1) to apply to deny the FUND a deduction under paragraph 104(6)(b).

H. Subsection 245(2) will not be applied to redetermine any of the tax consequences confirmed in rulings given above solely as a result of the proposed transactions described herein.

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002 and are binding on the CRA provided that the proposed transactions are completed within six months of the date of this letter.

The above rulings are based on the Act in its present form and do not take into account any proposed amendments to the Act. Nothing in this ruling should be construed as implying that the Canada Revenue Agency has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein other than those described in the rulings given.

On June 22, 2007, legislation pertaining to specified investment flow-through entities ("SIFTs") received Royal Assent. As you are aware the CRA is considering the issue of whether the subsidiary entities of, for example, an income trust, could be SIFTs, but has not yet reached a conclusion. Consequently, nothing in this ruling should be viewed as providing any assurance that LP is not currently a SIFT or will not become a SIFT by virtue of the proposed transactions.

VI. Opinions

A. The proposed transactions described in paragraphs 27 to 31 above will not, in and by themselves, adversely affect the qualification of the FUND as a mutual fund trust within the meaning of subsection 132(6) as that subsection is proposed to be amended by the Draft Amendments.

B. Section 253.1, as that section is proposed to be amended by the Draft Amendments, will apply in respect of the proposed transactions such that the FUND shall not be considered to be carrying on any business or other activity of LP, for purposes of paragraph 132(6)(b), as that paragraph is proposed to be amended by the Draft Amendments, solely because of its acquisition and holding of its interest in LP.

C. The implementation of the proposed transactions described herein, and in particular, the right to make any capital gains realized by the FUND on the disposition of securities of a Subsidiary of the FUND payable to Unitholders as described in paragraph 30 above, will not, in and by themselves, cause subsection 104(7.1) to apply to deny the FUND a deduction under paragraph 104(6)(b), as that paragraph is proposed to be amended by the Draft Amendments.

Yours truly,

Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch